- posted by Dave Desmarais in the Tax Blog
Harvesting investment losses at the end of the tax year to offset gains is undoubtedly one of the most common strategies investors utilize to reduce their tax liabilities. The Internal Revenue Service allows investors to sell off underperforming stocks up until Dec. 31 to count toward their 2013 returns, but waiting until the very end of the year could result in lost opportunities to maximize these losses, re-purchase stocks at a more favorable price and weigh the potential effects of the kiddie tax.
The timing in which investors sell off losing stocks carries great significance with regard to reducing taxable income and maximizing these losses. This is true for the three reasons listed below:
1. Year-end is arguably the most popular time to harvest losses, the anticipation of which can significantly affect stock prices. This scenario, coupled with reputed changes to and concerns regarding the U.S. Revenue Code, can send already low prices plummeting further. As a result, the losses already incurred by investors could be worse if prices decline closer to the end of the year. Therefore, investors who plan to sell underperforming stocks might benefit from selling prior to the very end of the month to secure a more favorable price.
2. Purchasing before the end of the year allows investors to re-purchase shares closer to the beginning of the new year when prices ascend. The IRS mandates a 30-day waiting period to repurchase shares of sold stock, but the earlier investors unload these shares, the sooner they may purchase them again before prices begin to appreciate.
3. Determining early on whether to sell losing shares enables individuals to assess the potential kiddie tax that may be imposed. It’s not uncommon for parents to put appreciated assets in their children’s names to generate wealth for their kids, while also avoiding having to pay taxes on the appreciation before transferring it to them. Federal laws, however, require that a child’s investment earnings over a certain threshold be taxed at the parent’s higher tax rate until the child reaches age 19 or, if the child is a full-time student, age 24. The 2013 limit is $2,000. Parents who anticipate higher investment earnings from their children’s taxes may reduce or eliminate unexpected gains by unloading assets that produce offsetting losses.
Determining whether to sell under performing stock
While unloading losing stocks well before the Dec. 31 deadline may make smart financial sense, it’s critical that investors carefully weigh whether to sell these stocks at all, which requires a critical long-term look into the potential advantages and drawbacks of this choice.
For instance, tax rates play a central role in this decision. Those in the lower tax brackets who will not incur capital gains taxes have more flexibility in making these determinations. Higher-income earners who will be subject to capital gains and might benefit the most from harvesting losses should consider the following questions:
- What is the potential rebound of deflated stocks and how long before they rebound?
- If selling shares of a mutual fund, are similarly priced and performing types of funds available from other companies?
- Might they be in a lower tax bracket in the following year?
- Might they have large short term capital gains in the following year and get a better tax benefit from using losses on those gains (as opposed to offsetting long term capital gains in the current year)?
There is no magic formula for determining whether to unload undervalued stocks, but our wealth, tax and advisory group can review an investor’s comprehensive portfolio to assist you in making an informed decision.