Last-Minute Tax Planning for Your Portfolio

If you own stocks, bonds, and mutual funds in a taxable account (outside of an IRA or 401(k) plan), you have a few weeks left to take actions that can favorably impact your tax return and your investment picture. Here are some strategies to consider.

Review Transactions

Look over the transactions you’ve made throughout the year. Also, review your paper transactions (whether you have a gain or loss position on holding that could be sold before the end of the year). Treat any nonbusiness bad debts (e.g., a loan to a friend that has gone sour) as short-term capital losses. Finally, check your 2008 return to see whether you have any capital loss carryover. With these bits of information, you can formulate a plan of action for the remainder of the year. Of course, in selling securities, don’t let tax results alone guide you; be sure to keep investment considerations in mind.

Offsetting Capital Gains

If you are already sitting with net profits (capital gains in excess of any capital losses), see whether there are any paper losses that can be realized before the end of the year. By offsetting your gains with losses, you wipe out tax liability. This is especially important if you have net short-term gains, which are taxed at ordinary income rates and not at favorable capital gain rates up to 15% (zero for those in the 10% or 15% bracket).

Keep tax rules in mind. Long-term gains and losses are those realized on assets held more than 12 months. Short-term gains and losses are those realized on assets held 12 months or less. Long-term losses offset long-term gains first. Then any excess long-term losses can offset short-term capital gains.

Taking Capital Losses

Capital losses in excess of any capital gains aren’t wasted. Instead, they can offset up to $3,000 of ordinary income ($1,500 if married filing separately). There had been proposals in Congress to increase the limit to $10,000, but nothing in regard to an increased limit has happened yet.

Capital losses in excess of capital gains and the limited amount of ordinary income can be carried forward. There is no limit on the carryforward period.

What about securities that may be worthless? In order to claim a deduction for worthless securities, they must be wholly worthless. The fact that a corporation is in bankruptcy is not sufficient to show worthlessness. There are two ways to get a write-off now for a security that you view as worthless:

• Sell the security, even for a nominal amount (sometimes brokerage firms will buy securities for $1 or so in an accommodation sale for customers). This will nail down the amount received in the transaction.
• Abandon the security. This simply means giving up any legal ownership rights (essentially turning your back on the security).

Beware of the Wash Sale Rule

When you actualize your paper losses, factor in the wash sale rule. This rule prevents investors from using capital losses if they acquire substantially identical ones within the wash sale period. This period is 30 days before or after the date of sale. It doesn’t matter that the 61-day period spreads over 2 years.

There are some tricky aspects to the wash sale rule. It can apply if:

• You sell securities at a loss in your taxable account and then cause your IRA to purchase substantially identical securities within the wash sale period.
• You sell mutual fund shares within 30 days of reinvesting a dividend in the fund.

Watch Out for Dividends

Stocks may declare dividends late in the year. In order to qualify for favorable tax treatment on the dividends, which is a maximum tax of 15% (zero for those in the 10% or 15% tax bracket), the shares must be held a minimum period. The stock must be held at least 61 days within a 120-day period beginning 60 days before the stock goes ex-dividend. Keep this time frame in mind when selling dividend-paying stocks.