Will Capital Gains Be Changed?

Currently, capital gains rates for the sale of assets held over one year are taxed at 15% (0% to the extent a taxpayer is in the 15% or lower regular tax bracket), compared with a top tax of 35% for ordinary income. Without Congressional action, these rates will increase to 20% (18% for assets held over 5 years) in 2013.

Although there has been some discussion related to extending the 15% rates for another year (2013), to date, Congress has not provided any indication one way or the other. Even without providing guidance for 2013, the House Ways and Means Committee and the Senate Finance Committee are already holding joint meetings to discuss capital gain reform.

Capital gains and related issues make up approximately half of the tax code, in excess of 20,000 pages. In addition, those with the most capital gains are generally the wealthier taxpayers, and lower capital gains rates contribute to the disparity in tax rates between the wealthy and the average working family that we hear so much about in the media. As an example, Billionaire Warren Buffet announced that his tax rate was 14%, which is lower than the rate paid by his secretary.

Some contend that capital gains should be taxed as ordinary income and should even be taxed as the income is earned rather than when the gain is realized.

Still others maintain that doing away with special long-term capital gains rates would discourage investment and would further harm the economy.

It is difficult to predict what lies ahead. But you can count on this firm to stay on top of this issue and to keep you abreast of the ever-changing tax landscape.

Fine-Tuning Capital Gains and Losses

The year's end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Let's consider some possibilities.

If there are losses to date - As an example, suppose the stocks and other capital assets that were sold during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), thereby offsetting those gains with pre-existing losses.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offsetting long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property's value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

If there are no net capital losses so far for the year - If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.

For the reasons outlined above, paper losses or gains on stocks may be worth recognizing (i.e., selling the stock) this year in some situations. But if the stock is sold at a loss with the idea to repurchase it, the repurchase cannot be within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock.

Careful handling of capital gains and losses can save substantial amounts of tax. Please contact this office to discuss year-end planning strategies that apply to your particular situation so as to maximize tax savings.