It’s Your Money: A year-end strategy that might cut your tax bill

“I’m proud to be paying taxes in the United States. The only thing is — I could be just as proud for half the money.” – Arthur Godfrey
I agree with Godfrey, the host of a show from the early days of television. Paying taxes may be patriotic, but most Americans don’t want to pay more than they need to.
Next year, you’ll find out what your tax bill is for this year. Actions you take before the end of 2014 can cut that bill.
One exercise that might yield tax savings is to look over your investment statements and check the column that says “Unrealized gain or loss.”
The stock market is near all-time highs, so most stocks or mutual funds you own are probably worth more than what you paid. But if you own something that is worth less than you paid, it could offer an opportunity.
Let me interject two caveats:
1. This only applies to investments held in a taxable account. It does not apply to stocks or mutual funds you hold in an IRA or 401(k).
2. The decision to sell an investment should be based on many considerations. To make the decision based only on taxes could be a mistake.
That said; let’s say you bought 100 shares of ABC Widgets for $100 a share — a $10,000 investment. Today, this imaginary company sells for $80 a share, so your 100 shares are worth $8,000. If you sell, you will take a $2,000 capital loss.
That loss can be used to reduce your 2014 taxable income by $2,000. If you’re a taxpayer in the 25-percent tax bracket, you would save $500.
The IRS allows you to use $3,000 in capital losses per year to reduce your ordinary income. If you take losses of more than $3,000, you can carry over the excess and deduct it in future years.
Losses can also be used to offset capital gains on assets you sold in 2014 for a profit, or capital gain distributions made by mutual funds. December is the month when many funds pay out capital gains. You might want to check with your broker or fund company to see if capital gains are coming.
But let’s say you believe the price of ABC Widgets will rebound. Wouldn’t it be nice if you could sell and take the $2,000 loss, then buy back your 100 shares, so you would benefit from a rebound?
Yes, it would be nice, but the IRS won’t allow it. If you buy shares of ABC Widgets within a 61-day window that begins 30 days before and ends 30 days after your sale, that’s a “wash sale” and will cause your loss to be disallowed.
If you believe the rebound you expect for ABC Widgets will lift the entire widget industry, then you can sidestep the wash sale rule by selling ABC Widgets for a loss and buying XYZ Widgets, a different company in the same industry, as long as that investment is not what the IRS calls “substantially identical.” If the widget industry rebounds, you’ll miss out on ABC’s appreciation but participate in XYZ’s.
I’ve strayed over the line between investment advice and tax advice in this column, and investors should consult a tax adviser when making tax decisions.
Also, it is not appropriate to offer one-size-fits-all advice. Every investor’s situation is unique. My goal is to alert you to a year-end strategy you might want to explore.
– Mark Rosenberg is an investment consultant with Financial West Group in Scotts Valley, a member of FINRA and SIPC. He can be reached at 831-439-9910 or [email protected].