Plan Ahead Using this Capital Gains Strategy to Lower The Tax Bill

December 17, 2012 | By Steven DiGregorio

While politicians do a sugarplum dance on the edge of the fiscal cliff, it looks more likely that many people will face a 20% federal tax rate on long-term capital gains in 2013. That rate will automatically kick in unless Congress extends the current 15% rate and the President goes along. Don’t bet your holiday cookies on those two things happening.

Those in higher income tax brackets will face the new 3.8% Medicare surtax beginning Jan. 1 on net investment income. The surtax will affect unmarried investors with adjusted gross income above $200,000 and married joint-filers with an adjusted gross income above $250,000.

Tax Savings Idea

Tax Savings Idea

But don’t give up hope. Here is a year-end strategy to consider as a “return on investment” perspective. 

What if you have some great long-term stock and mutual-fund winners in your taxable investment account that you don’t want to walk away from? Consider selling the shares before the year ends. You would owe the resulting 15% tax on April 15 of next year when your 2012 Form 1040 comes due. Assuming you still wanted to own the investment, after you sell, you can buy the shares right back and hold on to them as long as you’d like.

What could this strategy mean to you? Let’s do the math:

  • Assume an investor triggers $100,000 of long-term capital gains and a $15,000 federal tax hit by selling winners now, then buying the shares right back.
  • The $15,000 2012 tax hit will represent the “investment” in this strategy.
  • The “return” on the investment is the tax savings from having the gains taxed this year versus waiting until later when rates are higher.

Scenario 1 – 20% Capital Gains Rate and A Medicare Surtax

  • The investment in this strategy is the $15,000 tax bill ($100,000 x 15%).
  • If the investor would have sold next year, they would have owed $23,800 ($100,000 x 23.8).
  • That tax-savings benefit is $8,800 which translates into a 58.7% rate of return ($8,800/$15,000 = 58.67%).

Scenario 2 – 15% Capital Gains Rate and A Medicare Surtax

  • The investment in this strategy is the $15,000 tax hit ($100,000 x 15%).
  • If  the investor would have sold next year, they would have owed $18,800 ($100,000 x 18.8%).
  • That tax-savings benefit is $3,800 which translates into a 25.3% rate of return ($3,800/$15,000 = 25.3%)

Scenario 1 – 20% Capital Gains Rate and No Medicare Surtax

  • The investment in this strategy is the $15,000 tax hit ($100,000 x 15%).
  • If the investor would have sold next year, they would have owed $20,000 ($100,000 x 20.0%).
  • That tax-savings benefit is $5,000 which translates into a 30.0% rate of return ($5,000/$15,000 = 30.0%)

The Bottom Line

The game plan outlined here is definitely not foolproof nor does it apply in all circumstances, because nobody knows what the long-term capital gains tax rate will be for next year and beyond. Important to note as well, any profits that accrue after you buy back those winners will be higher-taxed short-term capital gains if you don’t hang onto the shares for more than one year.

The information herein contained does not constitute tax or legal advice. Any decisions or actions based on information contained herein should not be made without first consulting a CPA or attorney.

For more information contact Compass Asset Management Group, LLC at 845.563.0537 or Contact@CompassAMG.com

The author of this blog, Steven M DiGregorio is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC a Federally Registered Investment Advisory Firm. Securities offered through an affiliated company Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC.

Tags: 1040, capital gains rate, captal gains, economy, fiscal cliff, income tax brackets, investing, investment strategies, investments, medicare surtax, return on investment, roi, stock, tax, tax return, tax strategy, Taxes

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STEVEN M DIGREGORIO is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC.
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