Tax reform is creating a lot of uncertainty for most of us. However, despite the wrangling in Washington, there are a number of simple things you can do right now to reduce your taxes in 2017 and beyond. Here are a couple of ideas you might want to consider.
Some people think I’m crazy, but I love to take losses on my investments. Of course, I love gains more, but losses provide valuable tax benefits. If you sell securities at a loss, you can use your harvested losses to offset any gains you may have recognized during the course of the year. In addition, you can use $3,000 of capital losses to offset current year income. If you have more than $3,000 in losses, you can carry those losses forward indefinitely to offset future taxable income or capital gains.
When you harvest tax-losses, you need to be careful about two things. First, you need to avoid the “wash-sale” rule. The IRS prohibits an investor from purchasing a security that is “substantially identical” to the security that was sold within thirty days before or after the sale. If you violate the wash-sale rule, you will lose the loss you were trying to capture and you may end up with an unattractive cost basis on the security in question.
Second, you need to get your sale proceeds reinvested right away. You don’t want tax-loss harvesting to reduce your exposure to the market. Although the wash-sale rule says you can’t buy a security that is “substantially identical” to the security you sold, you can buy something that is similar. For example, if you harvest losses by selling shares in an S&P 500 index fund, you can reinvest those proceeds in a fund based on the Russell 1000 index. The two funds are similar, but they are different enough to avoid the wash sale rule.
Another year-end strategy to consider—especially after a strong stock market year like 2017—is to donate appreciated shares to charity. This strategy requires that you start with charitable intent (i.e., a desire to give to the charity), but it is very effective at avoiding the capital gains tax you would otherwise pay. An example illustrates how this works.
Let’s suppose you want to make a $10,000 donation to your favorite charity. Suppose further that you have a portfolio that contains two assets: cash worth $10,000 and shares of Amazon (AMZN) worth $10,000 with a cost basis of $2,000. Your first option for making your charitable gift is to write a check to the charity for $10,000. After the donation, you are left with a portfolio containing a single asset: shares of AMZN worth $10,000 and a cost basis of $2,000.
A second option is to donate your appreciated AMZN shares. As before, the charity gets a $10,000 gift. You, on the other hand, are left with $10,000 in cash. If you take that cash and buy AMZN shares, you will be left with a portfolio containing $10,000 worth of AMZN stock—the same portfolio as in your first option, but with a cost basis of $10,000. In other words, donating the appreciated stock washes your portfolio of the embedded capital gains.
Of course, everybody’s financial situation is unique. Give your financial advisor a call to see if these strategies are appropriate for you.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.