Tuesday, October 23, 2007


In this installment of my series on Year End Tax Planning I will discuss a change in the tax law for 2008 that may affect your 2007 year-end investment moves, and a way you can create a deductible capital loss from an investment you are not ready to sell.

* Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 the 5% capital gains tax rate on qualified dividends, capital gain distributions and long-term capital gains for taxpayers in the 15% and 10% tax brackets is reduced to 0% for tax year 2008 only. Taxpayers in at least the 15% tax bracket for tax year 2008 will pay absolutely no federal income tax on qualified dividends and capital gain distributions received in 2008, and on long-term capital gains from trades that occur in 2008.

I believe that this also includes the portion of the alternative tax calculation for qualified dividends and long-term capital gains that falls within the 5% category if such income would have been taxed partially at the 5% rate and partially at the 15% rate.

Keep this in mind when planning your 2007 year-end sales - and postpone selling investments that will produce a long-term capital gain until 2008 if all or part of the gain will be taxed at 0% and you do not have a substantial 2007 capital loss carryover to 2008.

If you have a $10,000 capital loss carryover from 2007 to 2008 and $6,000 in net capital gains for 2008, the $10,000 carryover will wipe out the $6,000 in gains and produce the maximum $3,000 net capital loss deduction for 2008. You will get no tax benefit from the 0% tax rate on long term capital gains for 2008.

If your capital gains will all be fully taxed at 15% in 2008, you may want to consider “gifting” an appreciated security that you plan to sell for a gain to a family member (i.e. an elderly parent) who will be in the 15% bracket and have that person sell the stock in 2008. This is a good way to provide support to your parents without being “out of pocket”.

You generally give your parents $20,000 each year to help toward their support, but are not able to claim them as dependents because of the gross income test. They are in the low end of the 15% tax bracket. You plan to sell an investment in 2008 that will generate $20,000 in gross proceeds and a $10,000 long-term capital gain. You gift the investment to your parents, and, as is the rule, your basis and holding period carry over to them.

If you sold the stock and gave your parents the cash you would have to pay $1,500.00 in federal (15%) and probably at least $500.00 in state income taxes. By gifting the stock to your parents in 2008, who then sell it to generate the needed support, you save the $2,000.00+ in income tax. The capital gains tax to your parents on the $10,000.00 will be “0”. As many states provide some kind of retirement income exclusion to the elderly your parents would probably not pay any state income tax either.

* If you have in your portfolio an investment (stock or mutual fund shares) that has gone down in value, but you have high hopes that it will go back up in the future and do not want to unload it yet, you can turn this paper loss into an actual deductible loss and still hold on to the security.

Sell the investment, wait 31 days, and buy back a matching amount of the same investment. Or you can first buy a second lot of the investment, wait 31 days, and then sell the original investment, specifically instructing your broker to sell the original lot.

In either case it is of vital importance that you wait the full 31 days before completing the transaction. Under the “wash sale” rules, the IRS will disallow any loss on the sale of an investment when the same or substantially identical securities and acquired within 30 days before or after the sale.
The wash sale rules do not apply in the case of securities sold at a gain. You may want to use this strategy to generate gains to wipe out an excess net capital loss for the year. You do not have to wait the 31 days discussed above. You can sell the stock for a gain on Tuesday and buy it back on Wednesday.
Above I talked about having a $10,000 capital loss carryover from 2007 to 2008. If your 2008 income, without counting qualified dividends, capital gain distributions and long-term capital gains, will put you in the 15% bracket, you can use wash sales to generate $10,000 in capital gains - thus freeing up any net long-term capital gains in 2008 to be at least partially taxed at the 0% bracket.
As an aside, New Jersey does not allow the carryover of excess capital losses. So if you have a net federal capital loss carryover from 2007 to 2008 of $10,000 this loss will be lost forever when it comes to NJ state income taxes, resulting in perhaps $552.00 in lost tax savings. See my post on "Capital Gains and New Jersey State Income Tax". A wash sale to wipe out your excess losses will save NJ state taxes in the future.

When it comes to year-end moves involving investments it is vital to consider the financial aspects of possible sale transactions. Putting off the sale of a stock that will generate a long-term gain until 2008 could result in a smaller profit due to a reduced share price. You should consult both your tax professional and your broker before making taking any action.

to be continued ……….


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