This year-end is proving to be one of the most difficult for investors in many years. There's the uncertainty resulting from the financial credit crisis and government reactions to the crisis. There's the uncertainty from the close presidential election. There is also the uncertainty from the existing tax laws, under which the tax rates for capital gains and dividends and the top marginal tax rates for ordinary income would increase in 2011 under current law even if nothing were done by Congress. Faced with this uncertainty, the market has been in retreat, evaporating gains and producing potential losses. While most investment advisors are advising clients to remain in the market, and even use downturns such as this as an opportunity for further investment, taxpayers facing investment losses should keep in mind some tried and true tax planning opportunities, as well as some potential new developments in the tax law.
CAPITAL LOSSES
Under standard, long-applied rules, short-term capital losses are offset against short-term capital gains and long-term losses are offset against long-term gains. Any net short-term losses are then offset against any net long-term gains and any net long-term losses are offset against any net short-term gains.
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Any net capital losses then may be offset against up to $3,000 of ordinary income (or $1,500 for those married individuals filing separately), with the balance carried over to future years, retaining its character as either short- or long-term. From a tax point of view, therefore, having $3,000 of net capital losses creates the best possible tax result for the current year by offsetting ordinary income that otherwise could be taxed at up to 35 percent.
WASH SALES
Taxpayers attracted to the idea of generating capital losses in order to offset ordinary income should be cautioned to observe the wash sale rules, also a long-standing part of the tax law. Selling a stock to generate a loss and repurchasing the same stock within 30 days on either side of the sale date will result in the loss not being recognized for tax purposes.
Taxpayers interested in generating losses while desiring to hold onto their present investments for long-term gain potential must therefore expose themselves to at least 30 days of reduced investment in the stock to preserve capital loss treatment. Some investors feel comfortable "getting around this rule" by repurchasing stock in a similar company with a similar balance sheet in the same industry.
THE CANDIDATES' TAKE
Under current law, existing capital gain, dividend and ordinary marginal tax rates will survive through 2010. The McCain campaign proposes preserving these tax rates beyond 2010. The Obama campaign proposes re-establishing the 36 percent and 39.6 percent marginal tax rates and raising the capital gain and dividend rate for those with incomes over $250,000 to 20 percent from 15 percent. If Obama is elected with a Democratic Congress, it's possible that he would push to enact his tax program in his first year in office, a successful strategy of several recent presidents.
