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addition to keeping your portfolio well balanced, you must also
be aware of the potential tax issues that exist anytime you
decide to sell a security. You need to regularly re-evaluate
your portfolio to ensure that your allocations and balances
are still appropriate. In doing so, you may identify investments
that have dropped in value and do not appear to be poised for
a rebound. If you decide to sell in order to reinvest in another
security with more potential, and have taxable gains from other
investments, a tax-loss sale can work to your advantage. This
is what the professionals at Fragasso Financial Advisors work to do on
your behalf as part of our normal year-end tax planning process.
Here is an example of how it can work: |
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An investor purchased $10,000 in ABC Stock Fund prior to December
31st in Year One. In December of Year Two the fund’s value
is $5,000, giving the investor a $5,000 long-term capital loss (LTCL).
NOTE: Tax-loss selling works only for funds held in taxable
accounts and not those in retirement plans, such as IRA’s and
401(k)’s.
The investor also owned XYZ Stock Fund, which distributed $1,000
in long-term capital gains (LTCG) in Year Two (a taxable capital
gain can come from a variety of investments, including the sale
of a stock, mutual fund or appreciated real estate).
NOTE:
To calculate taxes, the investor applies all capital losses against
capital gains, giving the investor a net capital loss of $4,000.
Realized short-term capital losses must first be used to offset
short-term capital gains, then long-term gains. Similarly, long-term
losses must first offset long-term gains, then short-term gains.
After first applying capital losses against capital gains, the investor
may apply excess losses against up to $3,000 in ordinary income,
including wages, dividends and interest.
The investor can now carry a net capital loss in excess of Year
Two capital gains and $3,000 in ordinary income for an unlimited
time until the loss is exhausted. Losses that are carried forward
retain their long- or short-term status and must first be used to
offset similar gains in future years, then may be applied against
ordinary income.
The investor now has to carefully decide what to do with the $5,000
from the sale of ABC Stock Fund from Step 1. Because most mutual
funds declare capital gains distributions in the fourth quarter,
the investor is at risk of buying a mutual fund that is poised to
make a capital gains distribution. This is a taxable distribution
even if reinvested and could erase the benefit of a tax-loss sale.
Also, the IRS prohibits taking a loss if an investor purchases the
same investment or a "substantially identical" investment
in the period beginning 30 days before the date of the sale and
ending 30 days after the sale. (For further information, please
contact your Fragasso Financial Advisors financial advisor or visit us at www.fragassogroup.com/directory.html.)
Bottom
line: Investment Decisions and Tax Issues Go Hand in Hand
The decision
to sell an investment that has dropped in value should not be made
solely on the basis of tax implications. Before deciding to sell
any investment at a loss, you should carefully consider the impact
on your total portfolio. But once you’ve identified a holding
you no longer believe is right for you, tax-related information
can make the decision to sell easier.
The professionals
at Fragasso Financial Advisors enlist this process when evaluating your portfolio
for possible adjustments. Our experience, commitment and knowledge
work collaboratively to ensure that you continue toward your financial
life goals.
For more
information or if you have any questions, please call 412-227-3200
or email me at michael_fertig@fragassogroup.com.
This article is for informational purposes
only and not intended as tax advice. Consult your tax advisor to
determine what is appropriate for your situation.
Past performance is no guarantee of future results.
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The Retirement Planning and Wealth Preservation Specialists Since
1972
610 Smithfield Street, Suite 400, Pittsburgh, PA 15222
Phone 412.227.3200, Fax 412.227.3210, Toll Free 1.800.900.4492
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