Tax Strategies for an Approaching Cliff

 | Nov 30, 2012 | 7:45 AM EST
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As we approach the end of the year, investors must decide how to deal with their 2012 realized capital gains. This year, the decision-making is complicated by the pending fiscal cliff, which brings with it the likelihood of higher capital-gains tax rates beginning in 2013.

While the issue of whether or not to realize embedded gains is complicated for many investors (and one we will address in an upcoming article), today we'll focus on an equally important issue: whether or not to offset previously realized gains by taking unrealized losses.

Many investors have questioned the wisdom of taking losses to offset lower taxed gains in 2012, rather than waiting to offset higher taxed gains in 2013. Our own feeling is that if capital-gains rates rise to only 20%, it's a no-brainer: Take losses now, because of the time value of money.

Even at a tax rate of 23% to 25%, we would be inclined to act now. Again, there is the bird-in-the-hand aspect of forgoing paying taxes now. In addition, next year might very well bring the opportunity to offset additional gains with additional losses. You might therefore have an offset opportunity next year, even if you take advantage of current losses now.

If you are inclined to realize losses in order to offset gains, the question becomes, do you want to sell a position and move on to another investment, or take the loss while holding on to the investment? In that regard, we refer you to our Aug. 28 piece, "To Hold or Not to Hold?" which focused on deciding whether to stick with losers.

You have until the very end of the year to sell a stock to realize your loss. However, if, for investment-driven reasons you want to stay with a position into 2013 but also want to realize a loss now, there are two specific and time-sensitive possibilities.

The first is the double-up strategy. Doubling up entails buying more of the stock you plan to sell, waiting 30 more days (starting the day after the buy), and then selling the original investment to realize a capital loss.

In order to make the sale count as a 2012 loss, you must not only wait 30 days after the date of doubling up or of sale, you must also sell the losing stock before the end of the year. (You can buy or sell on the 31st day.)

Therefore, today is the last day for an effective double-up, with a sale to take place on Dec. 31.

If one doesn't have extra cash sitting around to double up on a stock, an alternative approach is to sell and then to repurchase the stock, after waiting the required 30 days after the sale (though a repurchase can be in the following tax year).

With multiple losing stocks that you want to continue holding, you can combine the two strategies (and reduce the amount of funds needed to do it) by selling one stock and doubling up on the other, and then reversing both transactions 31 days later.

Since many times last year's losers become next year's winners (and frequently at the beginning of the new year after tax selling pressure has passed), it has often worked well to have sold and already repurchased desirable losers by the end of the year. In order to do this and effectively capture the loss, the sale must be made no later than today, with a Dec. 31 repurchase.        

A potential enhancement to the selling in order to repurchase is to purchase a similarly situated company (or a fund or ETF that roughly parallels the company just sold) for the duration of the 30-day waiting period. This second investment would then be unwound in order to complete the repurchase of the original stock.

While there have been some encouraging signs of a tax deal happening before year-end, there is no certainty that this will be the case, and we might not know 2013's rates until sometime next year.

This potential lack of clarity would also argue for taking action this year.



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