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Year’s end is time to pay attention to investment tax planning

Now is the time of year when you should be looking at year-end investment tax planning.

Much of this consists of reviewing any realized gains in your taxable accounts and seeing if you have any unrealized capital losses which, if sold, can be used to offset any gains. This is a sound strategy and one that can save you quite a bit of money if you are able to execute it.

One of the issues with this strategy, in light of the strong stock market performance over the past eight years, is trying to find investments with an unrealized loss. These are harder to come by. Yet, it’s a good problem to have. After all, the net reduction in taxes you will receive by selling a stock you have lost money in will never equal the actual loss you take by selling the stock.

For example, say you sell ABC stock and receive $ 9,000 when you paid $ 10,000 for it. The $ 1,000 loss can be taken as a tax deduction and may reduce your taxes by $ 150. This reduces your actual loss to $ 850.

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Still, overall, you still lost money. Obviously, you would have preferred seeing the investment increase to $ 11,000 so when you sold it, you made money even after taxes.

Since that strategy may be affecting fewer people, what else can investors do to lower their taxes when they sell investments?

One of the more overlooked strategies — one that can create huge tax inefficiencies if not looked at — is to be aware of the holding period of an investment you wish to sell.

The tax code distinguishes investments held for one year or less (short term) and then sold, from investments held and then sold after more than one year (long term).

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Short-term capital gains are taxed at ordinary income tax rates, while long-term capital gains are taxed at more favorable lower rates. The difference in the tax rate can be quite large.

An investor in the 39.6% tax bracket who also is subject to the net Investment Income tax of 3.8% will pay 43.4% tax on a short-term gain, but only 23.8% for a long-term gain, a 19.6% difference.

This can be triggered by an investor selling an investment prior to owning the investment for more than one year, locking in a short-term holding period. This is the case even if holding it only one day more would have changed the holding period from short-term to long-term.

Waiting to sell the investment until the holding period changes needs to be evaluated against a drop in the value of the investment, but the likelihood of the investment declining more than 19.6% is remote, making the decision to wait a better one.

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For investors in lower marginal tax brackets the difference between the rates is less, but still material. Someone in the 15% tax bracket, for example, will pay 15% tax on the gain on the sale of an investment held one year or less, but zero tax, on an investment held for more than one year.

Most investors can log onto their accounts online and see whether their individual investments are currently short- or long-term. But where many accounts fall short is in providing quick information as to when the short-term holding period will become long-term. For that, you may need to manually keep track.

If it is an investment you really want to sell, you may want to make a note in your paper calendar or set a reminder with your electronic calendar so you are aware of the holding period change.

There is another reason that the holding period is important. Donating appreciated stock to a charity is a nice way to help a charity without reducing your bank account. However, the value of your tax deduction is different depending upon your holding period.

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If you donate appreciated securities held greater than one year, the value of your donation is based on the fair market value of the securities at the time the securities were donated.

If securities that have been held one year or less are donated, your tax deduction is limited to the cost basis, or what you paid for the security when you first bought it. This too can be a huge difference, and it can be costly.

Focusing on the holding period of each of your investments can help save you taxes, especially as other tax planning strategies become harder to implement. The good news is by being aware of your holding period you can implement a tax-saving strategy throughout the year rather than waiting until year end and finding out there is nothing you can do.

Howard Hook, a CPA and Certified Financial Planner, is a partner in the wealth management firm of EKS Associates in Princeton, N.J.

[The content provided through this article and www.nydailynews.com should be used for informational purposes only and is not intended to be a substitute for professional advice. Always seek the advice of a relevant professional with any questions about any financial decision you are seeking to make.]

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