A Word About Tax Strategy

The market is up over 25% this year and even if you didn’t generate those kind of returns in your portfolio, you likely have some gains in the stocks and ETFs you hold.  You may be wondering if you should hold on to these investments or take your profits?  It is a good question since the market has had quite a run.  But in addition to considering the potential future appreciation your investments may or may not achieve, you will also want to consider the tax implications of selling your winners.  

It is important for you to know that when you take investment gains they are subject to the prevailing tax rules.  As of the end of 2013 the taxable rate for long-term capital gains ranged from zero to 20% depending on your tax bracket.  Short-term capital gains are taxed at your income tax rate.  So tax planning is critical to enhancing your long-term total return.  If you are investing in a 529 college plan or an IRA you don’t have to worry about taxes.  All gains (and losses) are tax exempt.  You don’t pay taxes on those funds until you begin to withdraw them and they are treated as income in the year(s) you do so.  So breathe easy about college and retirement accounts.  You will be able to maximize your total return in a tax-free environment (which, after all makes sense since you have already paid taxes on the acquisition of that money via income tax when you earned it in the first place).  Your savings account/ portfolio is another story.  In this case, though you’ve paid income taxes on the acquisition of this money as well, you will have to pay again if you generate gains.  But you can offset those gains against any losses you’ve realized.  And you can work to ensure all your gains are taxed at the lower, long-term rate (for stocks you’ve held over 12 months).

The rules for tax harvesting, as it is called, require that you may not buy any security you are selling for tax purposes for over thirty days before or after the sale of the security.  This is important because you may have a holding you like for the long-term but have a loss in for the short-term.  Selling that stock in order to realize the loss does not preclude you from buying it back.  But you must wait thirty days plus one.

Your discount brokerage platform will keep track of your unrealized as well as realized gains and losses.  Discount brokers keep track of what are called your tax lots.  Tax lots represent the increments in which you buy and sell securities.  Each trade is logged in as a tax lot and the broker keeps a schedule of how much you paid for that particular stock and when you purchased it.  Additionally you can view an up to date realized gain and loss schedule to assess your tax liability at any time during the year. The schedule will break your gains and losses into long and short-term segments–again providing valuable insight as you determine what, if any, year-end trades you may want to execute.   And for planning purposes you can review your unrealized gains and losses at any time during the year.  

I am not suggesting that you should hold onto stocks or ETFs simply to avoid generating taxable gains.  Taxes should not dictate your investment strategy.  I am simply suggesting that you should be aware when you create a tax liability so you can set aside funds to pay the taxes or find a corresponding loss you can realize to minimize your tax liability.

I trust you had a successful year of investing and look forward to sharing more ideas in 2014.


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