Make a Plan for Realizing Investment Gains

 | Dec 04, 2012 | 11:00 AM EST
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Last Friday, we wrote about the considerations concerning whether to offset previously realized 2012 capital gains with available losses. Our perspective was that, barring an announcement that capital gains rates would rise to 30% or higher, you should use available losses to offset 2012 gains.

Today, let's look at the flip side of the issue: Should you take unrealized gains as taxable profits in 2012? The considerations are whether to pay up sooner at a lower tax rate, as opposed to paying later at a higher rate.  

As is true of so many things, the correct short answer is, "It depends." The expanded answer is that it largely depends on your own circumstances.

As we stated last week, we believe that capital-gains rates are likely to rise incrementally but not dramatically. Our best sense is that rates will rise from the current 15% to a rate of 20% and possibly even 25%. (On top of this will be the new health care law surtax of 3.8%, which will apply to all forms of investment income except those generated by an actively managed business.) So rates are likely to rise to the 23.8% to 28.8% level. 

We all hope to have some clarity on capital-gains rates before Dec. 31, but you should set a general plan now and be prepared to act on an eventual tax and budget agreement. In the absence of definitive details, we believe the best working assumption is that capital gains rates will move up to the 23.8% level (20% plus the newly effective health care surtax).

All of this leads to a consideration of the time value of money, i.e., the differential between paying less tax sooner rather than the discounted value of paying possibly more tax in the future.

However, we believe the two most important factors should be your own needs for cash and your view of the investment merits of the particular stocks that you might sell for gains.

If you think you will need cash next year, it would probably make sense for you to take gains in 2012. The amount of gain to be realized should track your need for cash, including the tax required to cover the realized gain. Therefore it's not necessarily an either/or decision. You can take gains just to match your cash-flow needs.

Conversely, if you aren't in need of cash next year, then it probably makes good sense to hold on. This would be particularly so if you have a conviction that the stocks in question have good prospects. If a stock is close to hitting your targeted sale price purely from an investment consideration, and if you expect to sell it between now and early 2013, you might consider taking a portion of the gains in 2012 and the balance next year.

Another factor arguing for holding on would be that, while you might have a gain in a stock, there might be some continuing year-end selling pressure as other investors attempt to realize gains on the same stock as well. In 2012, year-end tax selling pressure might fall upon both winners and losers.

The bottom line from our perspective is that barring your needs for cash, making investment-driven decisions about selling is probably the wisest course.

So the combination of investment considerations, together with the benefit of being able to pay tax later, should provide, in the absence of a need for short-term cash, a strong inducement to hold winning stocks that you continue to like into 2013.

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