The stock market has been up for the year and the real estate market is solid in many parts of the country. Between now and New Year’s Eve, you may want to take actions—buying and selling—to improve your investment holdings. When doing so, take tax implications into account. Don’t make the following mistakes:
1. Buying into a dividend
If you buy stock just before it goes ex-dividend, you’ve purchased a taxable dividend with no real return from your investment. Typically, the value of the stock declines by the amount of the dividend that will be paid, so there’s no financial gain but you still owe taxes on the dividend you’ll receive. Don’t buy stock before it goes ex-dividend unless you’re confident the price of the shares will otherwise appreciate to offset your tax cost.
2. Ignoring the wash sale rule
Losses on investments are deductible in most cases. However, if you acquire substantially identical securities within 30 days before or after the date of the sale of securities at a loss, you can’t take the loss; the wash sale rule prevents it. Of course, taking losses and getting back into securities within this time frame may be advisable from an investment perspective, so consider securities that are not substantially identical. For example, if you sell a corporate bond at a loss, you could reacquire a bond with a similar maturity issued by a different corporation, or a bond by the same corporation with a different maturity.
Don’t try to avoid the wash sale rule by selling at a loss in your taxable account and then causing your IRA to buy the same security within the wash sale period. The loss in this situation is also barred by the wash sale rule. Watch out for the wash sale rule.
3. Missing a long-term holding period
To use the favorable tax rates on long-term capital gains—zero, 15%, or 20%, depending on your tax bracket—you usually must hold an asset for more than one year (at least one year and one day). Selling too early at a profit means you’ll pay the same tax rate that you’d pay on wages, bank interest, or other ordinary income. Check your holding period to nail down long-term gain treatment.
4. Wasting the IRA transfer option
If you’re 70-1/2 and older, you have the ability to make a direct transfer from your IRA to a public charity up to $100,000 each year. This transfer is tax free, even though it counts toward your required minimum distribution. If you don’t need the funds for yourself and want to benefit a charity, be sure to sign any necessary paperwork or give instructions so that the transfer can be made before the end of the year. Determine whether this special rule works for you.
5. Triggering the NII tax
If your modified adjusted gross income (MAGI) is “too high,” you’ll pay an additional tax of 3.8% on the lesser of net investment income or MAGI over the threshold. The threshold, which is not adjusted annually for inflation, is $250,000 for joint filers, $200,000 for singles, and $125,000 for married persons filing separately. MAGI includes investment income, so if you’re planning on selling investment property, determine whether the gain from the sale will put you over the threshold amount. If so, decide whether waiting until January makes sense for your situation. Decide whether sales can wait to save nearly 4% in taxes.
Tax results should never be the sole factor in making investment decisions. However, it surely is an important factor to consider. When in doubt, discuss your tax picture for the year and your investment objectives with your financial advisors so you can decide which actions to take before the end of the year.