If you’ve already realized taxable capital gains this year, consider taking losses on underperforming investments to offset your gains. But be sure to weigh all relevant factors before you make investment decisions.After you’ve assessed your tax situation, you’ll be ready to start reviewing specific planning steps. Here are some for consideration.
Capture Low Rates on Investment Gains
The tax rates on net long-term capital gains are still significantly lower than the rates that apply to short-term capital gains, interest, wages, and other ordinary income. A capital gain will be considered long term if you hold your investment more than one year before you sell it. The table below shows the long-term capital gains rates for different types of investments.
LONG-TERM CAPITAL GAINS RATES |
2011 |
Most investments (if ordinary tax rate is above 15%) |
15% |
Most investments (if ordinary tax rate is 10% or 15%) |
0% |
Collectibles |
28% |
Real estate (amount up to prior allowable depreciation; rest of gain is taxed the same as gain on most investments) |
25% |
Although taxes shouldn’t be the only factor you consider when you are timing investment transactions, waiting until you’ve met the long-term holding period before you sell an appreciated investment can save you taxes.
Use Capital Losses Effectively
No one likes to lose money on an investment. But there is a silver lining: Capital losses are generally deductible in full against capital gains and up to $3,000 annually ($1,500 if married filing separately) of your ordinary income. You may carry forward any excess capital losses you aren’t able to deduct under these rules for use in later tax years, subject to the same limitations.
The IRS has “wash-sale” rules in place to prevent taxpayers from selling securities to secure a tax loss and quickly purchasing substantially identical securities. If you sell securities at a loss and buy substantially identical securities within 30 days before or after the sale, you won’t be able to deduct your loss. Instead, it will be added to the cost basis of the replacement securities.
As you plan, size up your capital gain/loss situation. Do you have any taxable capital gains on 2011 investment sales? What about 2011 capital losses and capital loss carryforwards from prior years? Knowing where you stand from a tax viewpoint will be helpful when you are considering potential investment transactions before year-end.
Lock In a Low Rate on Dividends
Like long-term capital gains, qualifying dividends are generally taxed at a maximum rate of 15% in 2011 and 2012 — or 0% for dividends otherwise taxable in the lowest two ordinary tax brackets. Most dividend income received from domestic corporations and qualified foreign corporations can qualify, as long as you hold the underlying stock for a minimum period: generally at least 61 days during the 121-day period beginning 60 days before the stock’s “ex-dividend” date (the date on which the stock begins trading without rights to the most recently declared dividend). The holding period is longer for certain preferred stock dividends. Before you sell dividend-paying stocks, check to see if you’ve held the stock long enough to lock in a favorable tax rate on your dividend income.
Watch Income Timing
Part of your year-end tax planning may center on income timing decisions. For example, you may have an opportunity to delay receiving certain income — such as a late-year commission, bonus, or taxable distribution from a retirement account — until early next year. That way, you’d defer the related income taxes. Income deferral can have other tax benefits, as well. For example, deferral can help preserve certain tax breaks that are reduced or eliminated at higher income levels or prevent you from being pushed into a higher tax bracket this year. Of course, nontax considerations also will be important in any decisions you make regarding income deferral.
Accelerating income into the current tax year can be a smart tax strategy if you expect to be in a higher tax bracket the following year. Under current law, individual income-tax rates are not scheduled to increase until after 2012. However, if you expect a spike in income or a loss of significant deductions next year, your tax bracket might be higher in 2012 than in 2011.
Time Deductible Expenses
Timing also can be important on the expense side of your tax picture. If you itemize your deductions, you may be able to increase your deductions and cut this year’s tax bill by paying certain deductible expenses early, such as state and local taxes. However, exercise caution if the alternative minimum tax (AMT) could be an issue for you. State and local taxes, as well as certain other itemized deductions, are not allowed in computing the AMT.
Medical expenses and miscellaneous expenses deserve special mention because they are subject to deduction “floors.” Your itemized deduction for expenses in each category is limited to the amount that exceeds a percentage of your AGI. The floor is 7.5% of AGI for medical expenses. For example, if you have $25,000 of eligible medical expenses and AGI of $100,000, your deduction is $17,500 — $25,000 total medical expenses minus $7,500 (7.5% of your AGI). The floor is somewhat lower — 2% of AGI — for miscellaneous expenses, including unreimbursed employee business expenses, various investment-related expenses, and certain other items. To the extent possible, try to group your expenses in the year they’ll provide a tax benefit.
Certain expenses are deductible “above-the-line” as adjustments to income. Above-the-line deductions are valuable because they reduce your AGI and help you preserve tax breaks you might otherwise lose because your AGI is too high. Click here for the Taxable Income Worksheet that lists various above-the-line deductions that are available in 2011.
