Year-end tax strategies to consider when making investment choices

A few tax items should be considered when working on year end investment strategies. If you have losses in the year you should consider selling stock that has appreciated so you can use the losses to offset the gains. Consider selling appreciated assets before December 31 (if you think their value has peaked) to make use of an effective tax strategy of offsetting gains with losses.

Knowledge point:

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. You may use up to $3,000 ($1,500 for married filing separately) of total capital losses in excess of total capital gains as a deduction against ordinary income in computing your adjusted gross income (AGI).

Individuals are subject to federal tax at a rate as high as 37% on short-term capital gains and ordinary income. But long-term capital gains on most investments receive favorable treatment. They’re taxed at rates ranging from zero to 20% depending on your taxable income (inclusive of the gains). High-income taxpayers pay an additional 3.8% net investment income tax on their net gain and certain other investment income.

This means you should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they’re used to offset short-term capital gains or up to $3,000 per year of ordinary income. This requires making sure that the long-term capital losses aren’t taken in the same year as the long-term capital gains.

However, this isn’t just a tax issue.

Investment factors must also be considered. You don’t want to defer recognizing gain until next year if there’s too much risk that the investment’s value will decline before it can be sold. Similarly, you wouldn’t want to risk increasing a loss on investments you expect to decline in value by deferring a 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, take steps to prevent those losses from offsetting those gains.

If you’ve yet to realize net capital losses for 2021 but expect to realize net capital losses next year well in excess of the $3,000 ceiling, consider accelerating some excess losses into this year. The losses can offset current gains and up to $3,000 of any excess loss will become deductible against ordinary income this year.

For the reasons outlined above, paper losses or gains on stocks may be worth recognizing this year. But suppose the stock is also an investment worth holding for the long term. You can’t sell stock to establish a tax loss and buy it back the next day. The “wash sale” rule precludes recognition of a loss where substantially identical securities are bought and sold within a 61-day period (30 days before or 30 days after the date of sale).

However, you may be able to realize a tax loss by:

Selling the original holding and then buying the same securities at least 31 days later. The risk is interim upward price movement.
Buying more of the same stock, then selling the original holding at least 31 days later. The risk is interim downward price movement.
Selling the original holding and buying similar securities in different companies in the same line of business. This trades on the prospects of the industry, rather than the particular stock.
Selling an original holding of mutual fund shares and buying shares in another fund with a similar investment strategy.

Careful handling of capital gains and losses can save tax. Contact your Rudler, PSC advisor at 859-331-1717 if you have questions about these strategies.