You have probably noticed newspaper articles suggesting Year-End Tax-Planning Strategies. These are things that you may consider, between now and December 31, to reduce your Federal Income Tax for 2012. There is one idea that, over the years, I haven’t seen included in the Media, perhaps because it is rarely applicable.
During more normal years, investors often re-shuffle their Investment Portfolio–as well as other assets–to realize Tax Losses, which can offset Capital Gains. A portion of Losses that are over and above Gains may be written-off, but to a limited amount. Excess Losses can be “Carried Forward” to offset losses or reduce taxes in future years. Generally, investors do not realize Capital Gains until they have to, so as not to pay a Tax when they do not have to.
Suppose you own a security that is now trading at a Loss, as compared to your Purchase Price; however, you believe that it still fits into your Portfolio. The natural inclination might be to sell it, realize the Tax Loss, and buy it back the next day. The IRS says that you cannot buy the same security back before thirty days have passed; otherwise you will lose the benefit of the Tax Deduction, due to the so-called Wash Sale Rule.
What a lot of people do not understand, at least in my opinion, is that the Wash Sale Rule does NOT apply to Capital Gains. So, you can re-purchase a security the next day, next week, etc., without risking the Wash Sale Rule. BUT, WHY WOULD YOU WANT TO?
Currently, there has been considerable discussion as to what the US Federal Income Tax Rates will be next year. Additionally, will they change for Dividends and/or Capital Gains, as well? At present, no one knows for sure.
The IRS wording, regarding Wash Sales, is that you cannot buy “VIRTUALLY THE SAME SECURITY” back within 30 days. Again, it is my personal interpretation that this applies to Capital Losses only. Generally, most Tax Swaps, either to realize Gains or Losses, are used in the Bond Markets where you can sell, let’s say, $25,000 of State A Bonds, due on 6/2013, and buy $25,000 of State B Bonds , due on Oct 15, 2014. Thus, Gain or Loss, you didn’t buy virtually the same security.
Given the assumption that the Income Tax Rate will not really change for Family Incomes below $250,000 ($200,000 for an Individual), this could be a Non-Event for many people. Keep in mind, however, that the Tax-Rate on Dividends and Capital Gains could be a different issue. Also, the Interest on Municipal Bonds (issued by State and Local Governments), which is currently Tax-Free for Federal Income Tax purposes might be changed, at least above a certain amount.
I AM NOT A TAX PROFESSIONAL AND CANNOT GIVE TAX ADVICE. SO, PLEASE ADDRESS ANY SPECIFIC QUESTIONS, REGARDING YOUR PERSONAL SITUATION, WITH YOUR OWN TAX ADVISOR.