Capital Gains and Losses - Timing Is Everything!

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“The hardest thing in the world to understand is the income tax.”
-Albert Einstein

This article will lend insight into one of the few areas that investors actually can control in our new American Taxpayer “Relief” Act environment.

Accordingly, do your best to understand tax laws; have them work for your clients whenever possible. You can minimize portfolio taxes without compromising the essence of an investment strategy.

Unlike most forms of income, the timing of taxation on capital transactions is largely up to the investor. Regardless of economic gain, taxes are not incurred until investments are sold. With proper planning, tax rates should be far less than the marginal rate on ordinary income.

This article ignores state taxes, which could impact decisions. For example a client may be moving to or from a no capital gains tax state such as AK,FL,NV,NH,SD,TN,TX,WA and WY. If clients need to pay state taxes, the payment date can be critical. If included in the alternative-minimum tax (AMT) in the year paid, then no federal tax savings may result, as state taxes are a preference item.

The schedule D netting process

The top half of schedule D nets short-term (one year or less) realized gains against short-term realized losses/short-term loss carryovers from the prior year.

The lower half of Schedule D nets long-term realized gains plus capital gain distributions from mutual funds against long-term realized losses/long-term capital loss carryovers from the prior year.

Here are the possible outcomes:  

A) Net short and net long term gains – short-term gains are taxed at highest marginal tax rate and the long-term gains are taxed at capital gains rate (one of four different rates, depending on income: 0%, 15%, 20% or 23.8%);

B) Net short-term and net long-term losses – you can deduct up to $3,000 in losses against other income and carry forward any excess to the following year.

C) Net short-term losses or gains are different from net long-term losses or gains and produce an overall net gain or net loss – if a net gain, see A. If a net loss, see B. As an example, a net short-term capital loss of $7,000 and net long-term capital gain of $16,000 would yield a net long-term capital gain of $9,000 which is subject to the long-term capital gains rate.