Celebrate the harvest
If it’s been a while since you’ve had losses it’s time to refresh your memory. Stocks sold for a loss can offset taxable gains, including those fat ones that were distributed by mutual funds this year. Furthermore, investors who sell losers can use as much as $3,000 of those losses to offset regular income like wages and interest. That’s more than $1,000 in tax savings for someone in the middling 28 bracket in a medium-tax state. Investors who lock in so many losses that they use up their $3,000 offset and still have losses to burn can carry forward what’s left and use it in subsequent years.
This year there’s a new wrinkle. It’s another reason to dump bad stocks now. After Jan. 1, new lower capital-gains tax rates kick in. Most investors will be rewarded with a low 18 percent maximum tax on capital gains for shares they hold for five years, but here’s the rub: that holding period starts only after Jan. 1. Investors who’ve been holding shares that they want to keep can elect to treat them as if they are bought and sold in January, and take any gains they’ve accumulated to that point. But the new rules don’t allow investors to take losses on that move. So, sell ’em now, says Jim Seidel, an editor at RIA, a New York tax-research firm. If the prices are down, you’ll have lower gains or even losses that you can use on your Y2K taxes. Then wait 31 days, as the Internal Revenue Service requires, buy the same shares and get ready for that five year long haul.
Families can save even more money by giving winning shares to their kids, says Seidel. That’s because most kids who are over 14 are in the lowest tax bracket and will face a top capital-gains tax of 8 percent under the new rules. Furthermore, it will be easier for them to qualify for it, since they don’t have to wait until January for that holding -period clock to start ticking. Once the calendar flips to January, they’ll be able to sell shares you’ve already held for five years, and pay that percent tax on gains. That will net the family $1,200 in tax savings on a $10,000 gain. Of course, Junior gets to keep the proceeds.
Roth rules
Sen. William Roth, Republican of Delaware, lost his Senate seat this year, but his retirement account lives on, and this year’s saggy market offers opportunities there, too. Taxpayers contribute after-tax dollars to Roth Individual Retirement Accounts, but then the money the account earns is tax-free forever, and that’s better than the tax deferral offered by traditional IRAs. Savers can convert their old-style IRAs into Roths by paying income taxes on the amount of money converted. Young, low-bracket investors should choose a year like this one, when returns are low or negligible to covert that portfolio. But this year, some investors may have converted too early, like in September, when it looked like the market would just keep growing to the sky.
Not to worry, says Brent Lipshultz, a financial planner and CPA with KPMG. Complex /Roth rules let you change your mind. So if you converted to a Roth in September, and lost money in the market try this: you can undo you September conversion, wait 31 days (or until Jan.1, whichever is later) and then reconvert to a Roth. If you had a $40,000 IRA invested in s Standard & Poor’s 500 stock-index fund back in September, it’s worth just $35,000 today. Change your mind twice and you’ve saved $1,260 in federal taxes.
Fundamental Rules Apply
Finally, don’t forget the tried-and-true year-end strategies that can cut your tax bill come April and beyond. If you’re getting a bonus, ask your boss to hold off until January. Find out how much money you have left in your health-care savings account, and do whatever it takes–get the dental checkup and buy the extra eyeglasses–to spend it down before you lose it at the year-end. Write those extra checks, for property taxes, state income taxes and mortgages, to get your deductions in before Dec. 31, suggests Mark Luscombe, a tax attorney with CCH Inc.
All those savings can give you one more reason to rejoice in a sour market. By next April, you’ll be able to invest that fat refund check in some new bargain stocks.
