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Now's the time for capital gains planning

Possible changes to tax rates for 2013 make it important for investors to focus now on what would normally be year-end tax planning for gains and losses.

By MSN Money Partner Mar 9, 2012 2:46PM
This post is by Bernie Kent at


I usually advise investors to wait until the end of the year before making tax-motivated decisions regarding capital gain or loss recognition. Tax law changes at the end of the year could affect the rates for the current and/or subsequent years. Also, capital gains and losses could be dramatically affected by market forces during the year. These factors become clearer as year-end approaches.


This year may be different. Potentially significant changes in the tax rate on capital gains after 2012 suggest a more proactive capital gains strategy, starting now.

Long-term capital gains from the sale of securities are taxed at a maximum rate of 15% in 2012.  Short-term capital gains are taxed at a maximum rate of 35% in 2012.


In 2013, the Bush tax cuts are scheduled to expire. This would increase the maximum tax rate to 21.2% on long-term capital gains and 40.8% on short term capital gains. (The extra 1.2% is due to the return of the 3% disallowance of itemized deductions for income earned above a threshold.)  In addition, beginning in 2013, the health care law imposes a 3.8% tax on the investment income (including capital gains) of high-income taxpayers. 


These two changes would result in a combined 66.67% increase in the maximum federal long-term capital gains rates on the sale of stock in 2013 compared with a sale in 2012 (a 25% rate compared with a 15% rate).


Further, if President Barack Obama’s proposed "Buffett rule" is enacted, millionaires could face a minimum tax rate of 30% on their long-term capital gains as early as 2013.


What you should do now


The likelihood for significant increases in the long-term capital gains rates would suggest that you recognize your long-term gains in 2012 and hold off on selling your losers until 2013. (Post continues below video.)

You should avoid the active harvesting of tax losses that might otherwise be a part of your investment strategies. You can specifically identify which tax lot you are selling when you sell less than all of a position. Specific identification allows you the most flexibility in determining which tax lots are being sold.


For active traders, or investors who use money managers, specific identification may not be feasible. The 2008 Emergency Economic Stabilization Act requires brokers and custodians to report the tax basis of the lots that were sold. If you do not choose a method for selecting which lots are to be sold, the law requires that the FIFO ("first in, first out") method be used.


For 2012, most investors should now change the default method to "low cost," thus recognizing more gain in 2012 on the sale of partial positions at tax rates that are expected to be lower than in 2013. This saves the higher basis stock to reduce the gain in 2013.


Taxpayers with a capital loss carry-forward in 2012 have a dilemma. If you have a capital loss carry-forward that is smaller than your unrealized long-term capital gain position, you could plan on recognizing your capital gains this year and saving your unrealized capital losses for next year to take advantage of this year’s expected lower tax rates on capital gains. 


On the other hand if the capital loss carry-forward is so large that it will carry forward into 2013, there is no tax benefit to recognizing gains this year and losses should continue to be harvested. Some taxpayers will not know in which of these two positions they will be at year-end, which makes planning at this time even more difficult.




There are some exceptions to this unusual rule of holding losers and selling winners in 2012:

  • If you hold appreciated stock until death you will avoid capital gains tax entirely.
  • If you give long-term capital gain property to charity you will avoid the capital gains tax.

If you plan to avoid capital-gains tax by using either of these strategies you will lose out by recognizing gains in 2012. But since we can’t know when we will die, the strategy of recognizing gains in 2012 may end up being wrong in hindsight. Also, taxpayers whose incomes are in the range of the phase-out of the alternative minimum tax exemption could be in a 22% marginal tax bracket on long-term capital gains for 2012 and therefore may want to offset their capital gain this year.


Finally, if you have short-term capital gains in 2012, you should want to offset those gains with short-term losses (or long-term losses, if possible) unless you are fairly certain that you will have short-term gains in future years.


It is desirable to avoid having a net short-term capital gain taxed at ordinary income tax rates. Therefore, most taxpayers will want to offset short-term capital gains to the greatest extent possible. The rare exception would be if you have short-term capital gains every year and may benefit from recognizing the short-term capital losses against higher-taxed short-term capital gains in 2013.


Bottom line


The year 2012 could be an "upside down" year for many high-income taxpayers who will want to recognize their long-term capital gains and hold onto capital losses until 2013.  Every capital gains recognition decision should be considered on the basis of your specific situation, since there are so many different scenarios.


 While many decisions can be delayed until year-end, the need to focus on tax loss harvesting and tax lot selection is immediate. Higher expected capital-gains tax rates combined with low cost of capital make capital gain recognition in 2012 more attractive than any year in recent memory.


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Mar 11, 2012 11:29PM
The likelihood for significant increases in the long-term capital gains rates would suggest that you recognize your long-term gains in 2012 and hold off on selling your losers until 2013.

With market up 12% or more, net all your gains and losses this year before summer's sell off so you have least gains going forward and then wait for election results. If market looks to rebound in fall before election then start buying and figure out what to do next year at this time.


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