As 2005 draws to a close, it’s time to look at your portfolio and your trading results so far in 2005. If you wind up the year with net capital gains you’ll owe tax next April 15, when you file your 2005 tax return. Fortunately, savvy year-end maneuvering can turn what would have been a tax bill into tax savings.
- Begin by tallying all your trades for the year, figuring your profit or loss. Suppose, for example, you calculate that you have a $20,000 in net gains, all long-term, year-to-date. If you take no further action you’ll owe $3,000 in federal income tax, at a 15 percent long-term capital gains rate.
- Check to see if you have unrealized losses in your portfolio. If so, take those losses by year-end.
In our example, if you sell enough stocks, bonds, and mutual funds to realize $23,000 worth of losses, you will have a $3,000 net capital loss for the year.
A $3,000 capital loss is the maximum amount you can deduct from your other income. In a 28 percent effective tax bracket, you’d save $840 in tax (28 percent times $3,000) instead of owing $3,000. (Net losses in excess of $3,000 may be carried forward to future years.)
What if you think you’d still like to own the stocks or funds you sold at a loss?
- You can wait at least 31 days and buy them back. If you act sooner, you won’t be able to claim the capital loss on your tax return, under the so-called “wash-sale” rules.
- Another strategy is to immediately buy securities that are similar but not identical those you’ve sold. If you’ve taken a loss on a foreign-bond fund, for example, you can buy another foreign-bond fund right away without endangering your capital loss.
When you enter into year-end portfolio planning, don’t forget your mutual funds. Capital gains distributions are taxable income, whether or not they’re reinvested.
Many funds announce these distributions in December. Therefore, you should get your other records in order so that you can act immediately after you’re notified of any 2005 distributions.
For example, say you have $20,000 worth of net gains for 2005, as above. If you also receive $3,000 worth of capital gains distributions from mutual funds, that will put your net gain at $23,000, not $20,000. You’d have to take $26,000 worth of losses to wind up with a deductible $3,000 capital loss.
