Investor Education | Five year-end moves for securities investors
As we head into the home stretch of another year, consider the tax ramifications of securities transactions. Notably, the moves you make at the end of the year—or fail to make—could be worth thousands of tax dollars. Here are five popular strategies.
- Harvest capital losses. The losses you realize from securities sales at the end of the year can offset capital gains from earlier in the year plus up to $3,000 of highly taxed ordinary income. Any excess is carried over to next year. This traditional strategy is especially beneficial if the losses are used to offset short-term capital gains that would otherwise be taxed at ordinary income rates.
- Maximize capital gain benefits. Conversely, if you are showing capital losses from earlier in the year, capital gains realized at year-end are effectively tax-free up to the amount of the losses. Any excess gains are taxed at favorable capital gains rates. For long-term capital gains on securities held longer than a year, the rate is 15%, or 20% for someone in the top ordinary income tax bracket (0% for those in the two lowest brackets.
- Realize tax breaks for dividends. As with long-term capital gains, dividends are generally taxed at favorable tax rates. For instance, the tax rate for qualified dividends from U.S. companies is 15%, or 20% for someone in the top ordinary income tax bracket (0% for those in the two lowest brackets), similar to long-term capital gains. To qualify for the tax breaks, you must hold the securities for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date (i.e., the date dividends are declared.)
- Minimize the NII tax. Under a special tax law provision, a 3.8% tax applies to the lesser of net investment income (NII) or the amount that your modified adjusted gross income (MAGI) exceeds $200,000 for single filers and $250,000 for joint filers. The definition of NII includes most income items such as interest and dividends, capital gains, and gains from investments in passive activities. It does not include distributions from qualified plans and IRAs, but those increase MAGI. Plan your securities transactions accordingly to reduce or eliminate the NII tax.
- Avoid the wash sale rule. The wash sale rule prevents you from claiming a current loss on a securities sale if you acquire substantially identical securities within 30 days of the sale. Instead, the amount of the disallowed loss is added to your basis in the new securities. One popular year-end strategy is to wait at least 31 days before you buy back the same or similar securities you want to include in your portfolio. Alternatively, you might buy the securities you want and then wait at least 31 days to sell the original shares at a loss.
Of course, taxes are not the be-all and end-all. Weigh all the relevant economic factors concerning the sale and acquisition of securities. Obtaining professional assistance is recommended.
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