There are only a few days left in 2011. The new year starts on Sunday. If you have not done so already, this is the time to make the financial moves to save money on your taxes. By next week, it will be too late for 2011.
Note: As the disclaimer for this blog shows, I’m not a CPA. Tax laws are very complicated and change frequently (even the IRS gets them wrong from time-to-time.) You therefore should consult a CPA to verify the rules before you make a costly mistake. The following are just things I’ve learned from experience in managing a portfolio.
The basic rule for tax planning is to delay gains and pull losses forward. This means that it is generally better to get all of the deductions and take all of the losses you can in the current year and delay making gains until next year (or longer than that if you can). This is not true if, for example, your income is going to double next year so you will be in a higher tax bracket, but it is a good general rule for most people.
Based on this philosophy, here are some things to do this week:
1. Scour your portfolio for losing positions. If you feel that the underlying fundamentals of the company have changed such that it is time to sell anyway, do so this week so that you can bank the loss in 2011. If you also have gains in stocks and the positions have become so large that you would like to trim them back, you can sell some shares at a gain and directly offset your gains with your losses. You can also offset about $3000 worth of other income and carry the losses forward to offset income in other years if your losses exceed this amount. Again, check with a CPA on the specifics since this can get very tricky.
2. Make sure you have fully funded your children’s college accounts. This may not reduce your taxes now, but it increases the amount of money you will have to withdraw tax-free when your kids are ready to go to college.
3. Make last-minute contributions to IRAs and Roth IRAs (you actually have until April to make these contributions, but why not get them out-of-the-way early to make sure you don’t forget or do something else with the money).
4. If you have a losing position but would like to keep the shares (you feel the company has good long-term prospects even though the price has been beaten down) you might consider selling the shares for the loss and then buying them back later. Note that you must wait at least 30 days before buying them back or you will have a wash sale and not be able to deduct the loss. Note that you also can’t buy additional shares now and then sell the shares for the loss – you also have to wait 30 days after you bought the shares.
The issue with selling shares in a stock you like is that the company may take off after you sell before you are able to buy in again. You also might buy something else with the money while you are waiting and never get back into the company again. If there is another company in t e same industry that you also like, consider buying it with the proceeds of the sale. For example, if you own shares of Coke at a loss, you might sell them and buy Pepsi.
5. The wash sale rule does not apply if you are selling your shares at a gain (you can always take a gain and rebuy the shares whenever you wish). If you have a stock that has a large gain you might consider selling some shares and taking part of your gain now to split up the gain over different years. Assuming you have held the shares long enough to have a long-term gain the taxes are fairly low currently. If you still like the stock, buy it back immediately to avoid missing the future success of the company.
Note that you might delay selling the shares until next week to delay the gain into next year, but then again tax laws may change next year. Some of these laws apply retroactively to snag profits made early in the year.
6. Pay your property taxes on your home before the end of the year to bring the deduction into 2011.
7. If you have shares in a stock that has gone way up and you are now afraid it may fall, consider selling short-against-the-box. In this strategy you short the same number of shares you would like to sell and then allow the shares to wash out after the new year. This will lock in your profit (but you will also lose the ability to profit further if the shares rise).
8. Another strategy if you have a stock that has gone up a lot is to buy a January put option. This will give you the right to sell the shares at a predetermined price between now and mid January. This will lock in your profit but still allow you to participate, should the shares rally further. Typically such put options (assuming you buy one just below the current price of the stock) cost between $100 and $200 per hundred shares.
Take some time now to save money on your taxes in April.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.