Year-End Planning for Investors


Regardless of future legislation, some tried and true strategies will help investors trim their tax bill in 2017. Year-end loss harvesting can be worthwhile.

Example 1: Nick Rogers tallies his investment trades so far in 2017 and discovers he has realized $30,000 worth of net capital gains: his trading profits versus his trading losses. If those gains are all long-term (the assets were held more than one year), Nick would owe $4,500 to the IRS at his 15% rate.

Therefore, Nick goes over his portfolio to see if he has securities that he can sell at a loss. Although recent stock prices were generally strong, Nick has some energy and telecom shares that have lost value. If Nick takes $15,000 worth of losses in 2017, he will drop his net capital gain from $30,000 to $15,000, cutting his 2017 tax bill from his trading in half.

Example 2: Suppose that Nick can take $35,000 worth of losses by year-end. That would convert his $30,000 net capital gain for 2017 to a $5,000 net capital loss, avoiding any tax owed on Nick’s trades this year.

In addition, taxpayers generally can deduct up to $3,000 worth of net capital losses on their annual tax returns. Assuming Nick is in a 33% tax bracket, a $3,000 net capital loss would save him $990—much better than a tax bill of $4,500.

 

Don’t forget funds 

When you tally your year-end net gains or losses to date, don’t neglect to check your mutual funds. Many funds make distributions to shareholders in December; estimates of upcoming distributions may be posted on the fund’s website before the payout.

Whether you receive the money or automatically reinvest in more shares of the fund, distributions from funds held in a taxable account will be taxable. These payouts could be interest, dividends, or capital gains, and taxed accordingly. A distribution of short-term capital gains, for instance, may be taxed more heavily than a distribution of long-term capital gains.

Be careful of how you purchase funds near year-end. If you buy before the payout (technically, the “ex-dividend” date), you will receive the scheduled distribution and owe tax on that amount. (Reinvested distributions add to your basis, which would produce a better tax result when you sell the shares.) Conversely, if you wait until after the distribution, you’ll avoid the resulting tax and possibly buy at a lower price, as fund shares typically drop after the payout.

Selling shares before the distribution will enable you to avoid the tax on a distribution you haven’t received. You may sell at a higher price before the payout, which would increase your taxable gain or reduce your capital loss from the sale. The bottom line is that the timing of mutual fund trades can be a topic for discussion in year-end tax planning sessions.

 

Gaining from gains

In example 2, Nick has a net capital loss of $5,000 in 2017, of which he can deduct $3,000. What happens to the other $2,000? If he wishes, Nick can carry over that $2,000 loss to future years to offset future capital gains. There are no limits to the amount of losses Nick can carry over or the length of time he can do so.

Example 3: Yet another option is for Nick to sell enough assets to produce an additional $2,000 gain by December 31. This gain will be tax-free, because Nick can use his excess $2,000 net capital loss as an offset. If Nick wants, he can immediately buy back the shares he sold.

Why would Nick do this? To increase his basis in the shares he sold and bought. As mentioned, a higher basis will yield a better tax result on a future sale. This maneuver might work best with a mutual fund that does not charge for such transactions.

 

Going forward

After selling assets at a gain, an immediate repurchase can produce a smaller taxable gain or a larger capital loss in the future. A similar repurchase after a sale for a loss, though, can trigger the wash sale rules; then, the capital loss won’t count and no current tax benefit will be allowed. The amount of the disallowed loss will be added to your basis in the repurchased assets.

To avoid a wash sale after taking a capital loss, several tactics can be used. You can wait for at least 31 days and then buy back the security you sold, if you still want to hold it. If you don’t want to be out of the market that long, you can immediately buy another security that’s not substantially identical to the one you sold. Yet another possibility is to “double up.”

Example 4: As part of his plan to take losses near year-end, Nick intends to sell $10,000 worth of an energy stock that has lost value. He believes this stock is now well valued, so he wants to maintain his position in this holding.

To do so, Nick first invests another $10,000 in this stock, then waits 31 days and takes a $10,000 loss by selling shares that he previously held. Nick will wind up in the same position but will be able to take the $10,000 loss on the original shares. Because of the timing, a doubling up strategy must be initiated before the end of November to provide a 2017 tax benefit.