Year-end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Conventional wisdom has always been to minimize gains by selling “losers” to offset the gains from “winners” and where possible, generate the maximum allowable $3,000 capital loss for the year.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains (“long-term” means that the stock or property has been held over one year). Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to federal income tax at a rate as high as 39.6% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15% or 20%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided where possible, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires ensuring that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would be unwise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn’t want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

Long-Term Capital Gains Rates – The capital gains rates are 0% to the extent that your marginal tax rate is 10% or 15%, and 15% to the extent your marginal rate is between 25% and 35%. This means that the 15% capital gains rate will apply for individuals who file the single status with taxable income in 2017 between $37,950 and $418,400. The 15% capital gains rate for married couples filing jointly will be in effect if their 2017 taxable income is between $75,900 and $470,700. For higher income taxpayers – those in the 39.6% tax bracket – the capital gains rate is 20% to the extent in the 39.6% tax bracket. The tax brackets are annually adjusted for inflation, so please call for brackets for years other than 2017.

Individuals with large long-term capital gains in their investment portfolios might consider taking a profit up to the amount that would be taxed at 0%. The good news here is that the wash sale rules do not apply to assets sold at a gain. So if you like a stock, you are free to buy it back right away. If your state doesn’t have a lower tax rate on capital gains, then the additional state tax you’d pay from selling profitable capital assets will need to be weighed against the federal tax you’d potentially save when deciding whether to make tax sales before year-end.

Example: You are single with an annual taxable income (income minus deductions and exemptions), before including any stock gains, of $30,000. Thus, the first $7,950  ($37,950 – $30,000) of capital gains added to your income will be in the zero capital gains tax bracket (no tax). The next $380,450 ($418,400  – $37,950) of capital gains (without considering the 3.8% surtax on net investment income discussed later) would be taxed at 15%. After that, any additional capital gains are taxed at 20%. Thus when you take a gain, it can have a significant impact on the amount of tax you pay and careful planning can minimize the tax. This gives rise to the following strategies:    

  • If in any year some portion of your gain will be taxed at the zero capital gain rate, you should probably take that amount of gain since it produces no tax. 
  • If you have a substantial gain that when added to your other income will push some portion of the gain into the 20% capital gains bracket, you may be able to spread the gain over two or more years and keep more of the gain in the 15% capital gains bracket. This is done by structuring the sale as an installment sale. Unfortunately, the law doesn’t allow installment sales for publicly traded securities, so this strategy won’t work when you sell most stocks and bonds, but could be used when selling real estate.

Marginal Tax Rates – The marginal rates currently are 10, 15, 25, 28, 33, 35 and 39.6%. These rates apply to “ordinary” income including short-term capital gains.

Conventional wisdom has always been to defer income, but depending upon your tax bracket and future anticipated income, it may be appropriate to consider accelerating your income to take advantage of a lower tax rate.

Surtax on Net Investment Income – One should also be aware of the 3.8% Net Investment Income (NII) Tax that applies to higher-income taxpayers. This tax, part of the healthcare reform legislation, imposes a 3.8% surtax on the lesser of net investment income (investment income less investment expenses) or the amount that the modified adjusted gross income exceeds a threshold of $200,000 ($250,000 for joint filers and $125,000 for married individuals filing separately). Taking a large gain in one year can increase your income and make you susceptible to the NII tax. However, where possible you might spread that gain over two or more years, and avoid the surtax by using the installment sale method mentioned above.

Of course all of these tax-saving suggestions will go out the window if there is an overriding investment strategy or if there are investment risks to consider.

It may be in your best interest to review your current year tax strategy with an eye to the future in order to maximize your benefits from gains or losses associated with capital assets. Please call this office for assistance.

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