The decision to sell investments stems from various reasons, but has common challenges.
Whether you’re taking profits to pay off debt, or take a vacation; minimizing capital gains is a primary concern.
Since the top capital gains rate increased to 20% in 2013, even more investors are seeking ways to manage their tax liability. Thankfully, there are several ways to control how much you pay in capital gains.
Here are several strategies to consider when selling your investments:
Donate Appreciated Securities to Charity:
Charitable stock donations are valuable to managing your tax bracket. You can reduce your taxable income and avoid capital gains tax by donating stock to charities. The deduction is for up to 30% of AGI (Adjusted Gross Income).
Money managers such as Elliott Broidy and smaller investors each can benefit from changing their tax brackets. Individual tax filers can have up to $36,500 in ordinary income to qualify for the previous 15% capital gains rate. For married couples the benchmark is $72,500.
Would donating stock change your tax bracket?
Tax Loss Selling:
You can apply up to $3,000 in losses from other investments against ordinary income for that year. Any remaining balance is applied to future years, which is known as carry forward.
Investors are sometimes slow to acknowledge securities that have not panned out or are no longer a fit for their needs. Harvesting tax losses gives the financial motive to part with these lackluster holdings.
When taking losses to offset capital gains, the wash sale rule is a basic caveat to be aware of. This rule states you cannot buy an identical security 30 days prior to or after a tax loss sale to claim the deduction.
Harvesting losses and taking profits often have similar incentives. Portfolio rebalancing and changes in the underlying security may each be cause to sell holdings for losses or gains.
Aside from reducing the impact of capital gains, harvesting helps investors evaluate their current income tax brackets and time horizons.
Specific Identification of Shares:
The IRS assumes FIFO (First in First Out) when you sell securities. However, these shares could have a low cost basis, with more embedded capital gains than later purchases. When selling stocks or mutual funds, you can choose specific shares bought at higher prices to minimize capital gains.
Specific identification is more effective when you know how much money is needed for a particular purpose.
For instance, if you need to sell just enough stock to meet another expense, start with high cost basis shares and work down to raise the needed money.
It is best to manage your tax liability throughout the year, rather than frantic tweaks near year end. The importance of tax planning will vary based on income, age and time horizon.
Methods such as stock donations, tax loss selling and specific identification should be based on your unique needs. Tax strategies can vary by asset class or other factors. Real estate investors may consider 1031 exchanges, while parents may research 529 college savings accounts.
Please consult a tax professional if necessary.