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Tax compromise or coded tax talk?

Investors sell stock ahead of fiscal cliff, plus locking in 15 percent capital gains

Let me start by making it clear that I am not a stock guru. If I were, the hubby and I would be catching some rays right now from a Costa Rican beach.

But we do have investments and we watch them closely because we hope they one day will help us end up on a tropical shoreline full time.

Like a lot of investors we are not thrilled today to see the stock market tanking.

Wall Street sign by Alex Proimos via Flickr Creative CommonsPhoto by Alex Proimos via Flickr Creative Commons

Jim Wang, founder of the personal finance blog Bargaineering, noted over on Facebook:

"Stock market falling because of Obama's re-election. Given the projections that Obama was going to win, this is an example of buy the rumor, sell the news. But are US companies really 2%+ worse off than yesterday?"

It's a given that the markets hate uncertainty. So maybe the money men and women took Nate Silver's polling word for it yesterday and felt confident that President Obama would stay in the White House.

Even though a lot of investors aren't happy with the prez's continued/continual push for higher taxes on the wealthier among us, at least that's a fact they can deal with and the market closed up nicely on Nov. 6.

But money managers woke up today and apparently decided to again focus on the impending fiscal cliff. That means they must deal with the reality that while the Senate picked up a few more Democrats, the House is still solidly Republican and still firmly committed to any tax increases.

And that angst is leading to the losses, at least on paper, that are driving me crazy and theoretically making me push back my retirement a bit.

Taking lower-taxed gains: There also is a possible tax component to the selling.

Although investors have until the end of the year to make tax-related moves for 2012, a lot of people could be taking advantage of asset appreciation -- the Dow has, after all, gone up 67 percent and since Obama took office -- and locking in their gains at the current 15 percent tax rate.

Remember that one component of the fiscal cliff scenario is an increase in the long-term capital gains tax rates.

On Jan. 1, 2013, the capital gains tax rate will go from today's 15 percent to 20 percent.

Folks in the 10 percent and 15 percent tax brackets who now pay no tax on their long-term capital gains will next year be looking at a 10 percent tax on the profits from selling their assets. 

So maybe with the market doing well (before today) they just wanted to get this bit of financial and tax business out of the way before the holidays started sucking up all their time.

If you're so inclined to sell, November is also a good to unload some stocks that have appreciated.

You get the money to use for that aforementioned holiday shopping or travel.

You don't have to worry about time getting away from you as the year winds down.

Your profit might be better now. Again, I'm no stock expert, but when a lot of folks are dumping shares at the end of the year, the prices tend to drop, too.

No wash sale worries: And then are the wash sale tax considerations. 

Every investor knows that when you sell a stock at a loss and use that amount to offset other sale gains or, if you have more losses than gains, to offset up to $3,000 in ordinary income, you can't repurchase that stock for 30 days before or after the sale.

If you do, you'll lose the immediate advantage of claiming that stock loss.

Basically, the Internal Revenue Service doesn't want you selling an asset you truly thing is a good investment just for the stock tax loss and then rebuying it.

But there is no wash sale limit when you sell and make a gain.

So if you like a stock but it has appreciated substantially in the years you've owned it, take that gain in 2012 at these low capital gains rates.

But you really, really like this asset and believe it will continue to increase in value over the years.

So repurchase it.

You can use the money you made on the sale of the previously owned shares, again without wash sale tax worries because you made a profit.

Even if the capital gains rates are higher when you do eventually sell the repurchased shares, there will be less of them to tax at that higher rate.

And you'll have reset your basis in the asset. That should help keep your profit, and future tax bill, down.

Spreading out gains and taxes: Here's a very simple -- I'm just doing raw basis and not even worrying about the new 3.8 percent Medicare surtax on high earners -- example:

  • You bought 1,000 shares of XYZ at $10 a share in October 2010. Your basis in XYZ is 1,000 x $10 = $10,000.
  • You sold all your shares Nov. 6 at $30 a share, giving you a profit of $20,000.
  • Your long-term capital gains tax bill is $3,000: Sale price of $30,000 minus $10,000 basis = @20,000 gain x 15 percent capital gains tax rate = $3,000 tax due.
  • Today, Nov. 7, you bought 1,000 new shares of XYZ at $30 a share, giving you a new basis in the asset of $30,000.
  • A year and a day from now -- long enough to get the long-term capital gains rate -- you sell those shares at $40 a share.
  • Your $40,000 sales price minus your $30,000 reset basis gives you a $10,000 capital gain x 20 percent tax rate = a $2,000 tax bill.

Over the years, your total tax on your XYZ share transactions comes to $5,000. That's $3,000 from the first sale at the 15 percent capital gains tax rate and $2,000 from the second sale at the 20 percent capital gains tax rate.

But if you'd held the original stock and sold it all at once when the 20 percent rate was in place, your total tax bill on XYZ capital gains would have been $6,000: $40,000 from the sale a year+ from now minus $10,000 original basis = $30,000 gain x 20 tax rate = $6,000 tax bill.

By splitting your gains over two tax years you saved $1,000 in taxes.

What's next? Who knows if the 20 percent capital gains tax rate will take effect as scheduled in a few weeks? Not a soul.

We're all guessing here what Obama and Congress will or won't do, hence the nervousness on Wall Street and falling stock prices today.

And while as I've repeatedly noted I am not a stock guru, I do know that you should never, as the old saying goes, let the tax tail wag the investment dog.

You need to look at your portfolio, talk with your financial and tax adviser(s) and make any  sell (or buy) calls based on your own needs and goals.

But I just thought I'd throw this scenario out there as something else to consider.

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Hyip Monitor

Very nice article thanks for sharing your great ideas.

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