Here’s the basic strategy:
- Avoid the high taxes (up to 40.8 percent) on short-term capital gains and ordinary income.
- Lower the taxes to zero—or if you can’t do that, then lower them to 23.8 percent or less by making the profits subject to long-term capital gains.
Think of this: you are paying taxes at a 71.4 percent higher rate when you pay at 40.8 percent rather than the tax-favored 23.8 percent.
The beauty of tax planning your year-end stock portfolio is that it might cost you pennies in commissions but allow you to pocket real money.
Examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent). In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.
Use long-term losses to create the $3,000 deduction allowed against ordinary income. Again, you are trying to use the 23.8 percent loss to kill a 40.8 percent tax (or a 0 percent loss to kill a 12 percent tax, if you are in the 12 percent or lower income tax bracket).
As an individual investor, avoid the wash-sale loss rule. Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before the date of sale or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.
If you want to use the loss in 2018, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.
If you have lots of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains. If you sell stocks to purge the capital gains, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule.
Important. Don’t die with large capital loss carryovers—they’ll disappear.
- If your carryover originated from you only, then it all goes away if not used on your joint return in the year of your death.
- If your carryover came from joint assets, then your surviving spouse gets 50 percent of the carryover to use going forward.
Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)? If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. Why? If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by
- gifting them stock,
- having them sell the stock, and then
- having them pay taxes on the stock sale at their lower tax rates.
If you are going to make a donation to a charity, consider appreciated stock rather than cash because a donation of appreciated stock gives you more tax benefit. It works like this:
- Benefit 1. You deduct the fair market value of the stock as a charitable donation.
- Benefit 2. You don’t pay any of the taxes you would have had to pay if you sold the stock.
If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity. Why? If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss—in other words, you can just kiss that tax-reducing loss goodbye.
Solution. Sell the stock first to create your tax-deductible loss. Then give the charity the cash realized from your sale of the stock to create your deduction for the charitable contribution.