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Year End Capital Gains Planning

Need to plan your yearend Capital Gains now


Why You Need To Do Your Yearend Capital Gains Tax Planning Now


I usually advise investors to wait until yearend before making any 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 yearend 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. 

Capital gains tax rates in 2012 and 2013

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 Obama Health Care bill 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 2/3% increase in the maximum federal long-term capital gains rates on the sale of stock in 2013 compared to a sale in 2012 (a 25% rate compared to a 15% rate). Further, if President 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. 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 which 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 carryforward in 2012 have a dilemma. If you have a capital loss carryforward 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 carryforward 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 yearend, 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:

  1. If you hold appreciated stock until death you will avoid capital gains tax entirely.
  2. 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, alternative minimum tax (AMT) taxpayers whose incomes are in the range of the phase-out of the AMT 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-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 of 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 personal situation, since there are so many different scenarios. While many decisions can be delayed until yearend, 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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