When determining whether to buy or sell a security, several factors may affect your decision: your goals, time frame, and risk tolerance, to name a few. One factor that should never be dismissed, however, is the tax consequence(s) of your purchase or sale. Despite what you may have heard, this is relevant even if you’re in or below the 15 percent income tax bracket.
With proper tax planning, it’s possible to recognize a certain amount of capital gains tax-free. Here are a few tips to get started:
Timing can play a significant role in the tax consequences of your investment activities. That’s because your ordinary-income tax rate could be much higher than your long-term capital gains tax rate. Generally speaking, the long-term gains rate applies to investments held for more than 12 months, but it all depends on your income level and the type of asset.
Good news: Your long- and short-term gains and losses can offset one another. So if you’ve realized big gains throughout the year, consider minimizing your 2016 tax liability by selling your unrealized losses. (Make sure you act before year-end.)
If you buy a mutual fund with a high turnover rate, it could create income that’s taxed at ordinary-income rates. Instead, choose funds that provide primarily long-term gains—which are subject to lower long-term rates. Keeping an eye on your earning reinvestments is a good idea, too. If you (or your investment advisor) aren’t increasing your basis accordingly, you could end up reporting more gain than necessary when you sell the fund.
Equity mutual funds tend to declare large capital gains distribution at year-end. If this happens, you could be left with an unwelcome tax surprise: If you owned shares on the distribution date, you could be taxed on the full distribution amount—even if the amount includes gains realized earlier in the year.
If you don’t come out ahead at year-end, there’s a silver lining. When net losses exceed net gains, you can deduct up to $3,000 ($1,500 for married taxpayers filing separately) of the losses per year against dividends or ordinary income such as wages, self-employment and business income, and interest. Excess losses can be carried forward indefinitely, giving you a particularly effective tax-saving tool in future years.
Talk to Your Tax Advisor.
There are other tax consequences you should consider beyond losses and gains. And, if your modified adjusted gross income (MAGI) exceeds $200,000 per year ($250,000 for joint filers and $125,000 for married filing separately), you could be subject to net investment income tax (NIIT)—something else to think about. Your tax advisor can help you plan for these, as well as guide you through the other tax planning tips. As we approach year-end, now is a great time to start. For more information, contact Jen Verly.