doesn’t get much better.
Near the end of each year, we tend to talk a lot about tax loss harvesting. It’s a popular use of ETFs, where an investor sells an underperforming stock or fund at a loss, buys an ETF with a similar exposure and risk profile, and holds the ETF for the 30 day “wash sale” period during which they’re prohibited from re-purchasing the original security in order to claim the loss for tax purposes. The strategy is designed to capture the capital loss and possibly lower taxes for the year, while maintaining exposure to the intended security or asset class. (By the way, this is a good strategy to use anytime throughout the year, as you may not have any losses to harvest if you wait until December.)
Following the market upheavel of 2008, most of us did not have any trouble locating losses in our portfolios! With markets now up sharply from those lows, many of you may now happily find yourselves in the opposite situation, and if so I have a tip for you: think about selling a little bit of your appreciated investments this year and next. It’s called tax gain harvesting.
Particularly if you were at or near retirement age at the time, you may remember hearing something about 0% capital gains tax as part of the Bush tax cuts. As originally designed, this break was aimed at taxpayers in the 10% and 15% tax brackets (married couples with incomes up to $69,000) and applied to long-term capital gains and qualified dividend income. Since the $69,000 represents adjusted gross income, couples could have gross income (including tax-exempt income) substantially higher than this and still qualify for the 0% rate on capital gains once they have applied deductions and other adjustments.
Married Filing Jointly 2011 Tax Brackets
|Taxable Income||Marginal Tax Rate:|
|$0 – $17,000||10%|
|$17,000 – $69,000||15%|
|$69,000 – $139,350||25%|
|$139,350 – $212,300||28%|
|$212,300 – $379,150||33%|
As part of the 2010 Tax Relief Act, the 0% rate was extended for another two years (through the end of 2012), so if you missed this opportunity the first time, you have another chance now.
Now, as with most things tax-related, there’s a trade-off. If you’re an upper income taxpayer and still in your higher earning years, you probably want to maximize losses before gains. In other words, since your higher income won’t allow you the tax advantage of 0% on capital gains, you might prefer to sell securities where you have losses and offset any gains up to $3,000 in ordinary income.
I know of some financial planners who are also advising their higher income clients to be more aggressive and sell some of their appreciated investments now to lock in the current 15% long-term gains rate, which could move higher in the future, particularly if the Bush tax cuts are not extended again. That’s not an unreasonable strategy, but you should do the math on it. Any amount you pay in taxes now won’t earn a return in future years, and it could be years before the current long-term capital gains rates rise.
If, on the other hand, you or one of your family members do qualify for the 0% capital gains rate, you can maximize the benefit of that now.
The Internal Revenue Service has not released a definitive opinion regarding the definition of “substantially identical” securities and its application to the wash sale rule and ETFs. The information and examples provided are not intended to be a complete analysis of every material fact respecting tax strategy and are presented for educational and illustrative purposes only. Tax consequences will vary by individual taxpayer and individuals must carefully evaluate their tax position before engaging in any tax strategy.
Kevin Feldman, CFP® is a Managing Director in the iShares unit of BlackRock, the world’s largest asset manager. He has responsibility for iShares marketing, analytics and education. Mr. Feldman’s service with the firm dates back to 2007, including his years with Barclays Global Investors (BGI), which merged with BlackRock in 2009. At BGI, he was Director of Global Web Solutions, where he had responsibility for online education, portfolio analysis tools and global product data. Mr. Feldman earned a BA degree from the University of California, Los Angeles and an MPA degree from Harvard University.
The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.