PLANNING WITH CAPITAL GAINS AND LOSSES

 

Watch Out For Incentive Stock Options And AMT.  If you exercised an incentive stock option (ISO) in 2004, the exercise could trigger the alternative minimum tax (AMT) on your 2004 return. Your AMT income includes the excess of the fair market value of the stock acquired upon the exercise of the  option over the exercise  price. This excess is not included in calculating your regular income tax for 2004 but is included in calculating the AMT.  The exercise of the option could create a large tax bill even if the value of the stock you acquired plummets after the date of exercise. Tax Tip.  If you exercised an ISO in 2004 and the stock you acquired has declined in value since the date of exercise, it may be possible to eliminate or reduce your AMT tax liability if you sell the stock on or before December 31, 2004.  Please check with us if you have exercised incentive stock options during 2004 and the price of the stock has fallen since the date of exercise.  A sale of the stock after December 31, 2004 will not affect your AMT liability for 2004. So, we must act timely for a sale to reduce 2004 taxes!

 

Year-End Considerations For Capital Assets.  Timing your year-end sales of stocks, bonds, or other securities may save you taxes.  After fully evaluating the economic factors, the following are several year-end tax planning ideas for sales of capital assets.  Caution! Always consider the economics of a sale or exchange first!

 

$     Taking Capital Losses To The Extent Of Capital Gains Plus $3,000.  If you have already recognized capital gains in 2004, you should consider selling securities that have declined in value prior to January 1, 2005. These losses will be deductible on your 2004 return to the extent of your recognized capital gains plus $3,000.  Capital losses in excess of $3,000 are carried forward and offset capital gains for future years. These losses may have the added benefit of reducing your income to a level that you qualify for other tax breaks (e.g., the child credit, the HOPE credit, and IRA contributions). Planning Alert!  If within 30 days before or after the sale of loss securities, you acquire the same securities, the loss will not be allowed currently because of the wash sale rules. 

 

$     Making The Most Of Capital Losses.  Remember, if your stock sales to date have created a net capital loss exceeding $3,000, consider selling enough appreciated securities before year end to decrease the net capital loss to $3,000. Stocks that you think have reached their peak would be good candidates.  All else being equal, you should sell the short-term (held 12 months or less) securities first. This will allow your short-term capital gain to absorb your net capital loss (in excess of $3,000), while preserving your favorable long-term capital gain treatment for later years.

 

$     Year-End Mutual Fund Purchases.  If you are thinking about buying mutual fund shares near year-end, watch out for a common tax trap.  Mutual funds typically distribute income, including capital gains, near the end of each year. If you invest in the fund near the end of the year, but on or before the record date for this payout, you generally will be taxed on a year-end distribution as if you had held the fund all year.  This, in essence, treats a return of your investment as a taxable distribution.  Before investing, determine the amount and timing of any year-end payout.

 

Stock "Traders" May Save Taxes By Electing "Mark-to-Market.  If you are a "trader" in stocks, the "mark-to-market" election could possibly save you taxes. If you invest in stocks, the IRS will generally consider you either an "investor" or a "trader" (unless you sell securities to the general public).  Generally, the IRS will treat you as a "trader" if you have frequent purchases and sales of stock, you hold the stock for short-term gain (rather than long-term appreciation and dividends), and you have a high volume of stock transactions for the entire year.  If you qualify as a trader, you can elect (for tax purposes) to mark your stock down or up to market at year end.  This election will convert what would generally be short-term capital gains and losses, into "ordinary" gains and losses.  Tax Tip.  This election could save taxes if you anticipate incurring significant capital losses.  Each tax year you can only deduct $3,000 of the amount by which your capital losses exceed your capital gains. However,  if you make a timely "mark-to-market@ election, you can fully deduct those losses as "ordinary losses." Also, making this election will not subject your mark-to-market stock gains to Social Security or Medicare taxes. Planning Alert!  Unless you made the election for a prior year, the mark-to-market election, unfortunately, must be made by the due date (without regard to extensions) of your prior year’s tax return.  Even though it is too late to make the election for 2004, you may wish to make the election by April 15, 2005 for 2005 and future years.  Tax Tip.  For new taxpayers (e.g., a partnership created to trade securities), the election is due within two months and 15 days after the creation of the entity. For example, a partnership created on October 1, 2004 should have until December 15, 2004 to make the election. Please call us if you think this election might save you taxes-we will be glad to fill you in on the details.