Connections for Success

 

02.12.20

Capital Gains Planning: When Timing is Everything
Adam M. Levine

The timing of capital gains and losses may have a significant impact on your tax bill. So it pays to consider the tax implications before you sell investments, particularly as the end of the year approaches.

The Long and short of it

Generally, the longer you hold an appreciated investment, the better. It allows you to defer taxes, which maximizes growth and may reduce the tax if you are in a lower tax bracket when you sell. Additionally, holding an investment for more than a year allows you to take advantage of lower long-term capital gains tax rates.

Short-term gains — assets held for one year or less — are taxed at ordinary-income rates, which could be as high as 37%, depending on income level.  If you hold an asset for more than a year, you will qualify for favorable long-term capital gains rates.  Depending on your income level, the preferential rate could be 15% or 20% (plus 3.8% net investment income tax, if applicable).  

When sooner is better

If you plan to sell an investment at a loss, it may be advantageous to do so before you reach the one-year mark. That is because, to determine your net capital gain or loss in a given year, you begin by offsetting gains and losses of the same type (long- and short-term investments).

Say, for example, that you have already recognized $10,000 in short-term capital gain and $10,000 in long-term capital gain this year. You also own a stock, purchased just over 11 months ago, that has declined in value by $10,000. If you sell the stock now, you will have a $10,000 short-term loss that offsets your $10,000 short-term gain. This leaves you with a $10,000 long-term gain taxed at a favorable rate. But, if you wait a month until you have held the stock for more than a year, the long-term loss must be used to offset the long-term gain, leaving you with a $10,000 short-term gain taxed at the higher ordinary rate.

Strategic gains and losses

You need to think strategically when taking capital gains and losses. If you plan to sell investments that will generate both capital gains and losses, doing so in the same year allows you to offset losses against gains and reduce your tax bill. In some cases, however, it may make sense to postpone gain until the following year.

Taxpayers are permitted to deduct up to $3,000 in capital loss from their salary or other ordinary income. Suppose you have a $3,000 net capital loss in 2019. You also own a stock whose sale would yield a $3,000 long-term capital gain. If you wait until 2020 to sell it, the gain will be taxed at favorable long-term rates and you will be able to deduct this year’s $3,000 loss from your ordinary income. But if you sell the stock this year, the gain will offset the capital loss and you will not be able to use it to offset ordinary income.

Taxes are not everything

Keep in mind that tax considerations alone should not control your investment decisions. However, understanding the tax consequences of various investment strategies can help boost your portfolio’s returns.

For more information, contact Adam M. Levine at alevine@orba.com or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

© 2020

6 responses to “Capital Gains Planning: When Timing is Everything”

  1. I have lots of capital losses going back several years. This year I have stock that would produce very good capital gains. When should a sell for a capital gain to eat away at past capital losses and then buy it back later at a lower price?

    • In general, if you plan on retaining the investment, selling and re-purchasing to simply report the gain and use the capital loss carryovers is generally not beneficial. You would end up in the same situation from an investment portfolio standpoint, but have less capital loss carryover that can be used against any future gains. On the other hand, if you feel like the investment has become over-priced or an outsized part of your overall portfolio, selling and diversifying or de-risking the portfolio makes sense. In essence, the decision should be driven by your overall investment strategy. The losses will remain available throughout your life so using them strategically to adjust your portfolio is the wisest course of action. If you would like advice geared to your personal situation, please feel free to reach out to an ORBA advisor directly or FWashelesky@orba.com

  2. Example St loss -100K LT gain 160K
    Unrealized ST gains 150K
    Should u keep the 100k ST loss for the following year? Is it even possible?
    And pay the LT tax Assuming most will be realized as ST (options etc.)
    I realize the gamble of relying on the future gain.
    Thanks

    • The realized ST loss would be used against the realized LT gains. You do not have a choice. The options to get the best tax result would be to either:

      1. Sell the ST gains in the same year as the losses as the ST gain and loss would net first and any excess ST loss would offset LT gains.
      2. Hold the assets that are creating the unrealized ST gains for over a year so they become LT gains before they are sold.

      Which is better, is an investment decision.

      For additional assistance, please reach out to me at FWashelesky@orba.com

  3. Very useful information–thank you!

    If you have carryover capital losses (for example $100,000 in 2018), can you use 100% of your capital loss in one or two years (for example $50,000 in 2019 and $50,000 in 2020) to offset capital gains? I keep reading there is a $3,000 limit per year, so that is somewhat confusing.

    Thank you for your time,

    Justin

    • Capital loss carryforwards are utilized first against any capital gains generated in future years plus an additional $3,000 per year until they are completely utilized. For example, if you have a capital loss carryover from 2019 of $100,000 and generated $70,000 of capital gains in 2020 and $50,000 of capital gains in 2021, your carryforward would be used as follows:

      Carryover available to 2020 $100,000
      Used to offset 2020 capital gains ( 70,000)
      Additional amount that can be used
      against other income in 2020 ( 3,000)
      Carryover to 2021 $ 27,000
      Used to offset 2021 capital gains ( 27,000)
      Remainder None

      In the above case, you would use the entire amount in two years and have net capital gains of $23,000 reported as income in 2021.

      For additional assistance, please reach out to me at FWashelesky@orba.com.

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