Consider your investments in terms of next April's taxes
It's time for investors to start thinking about next April's tax return.
Why? Is some deadline looming?
No. It's always time to be thinking about taxes, even though the subject grabs most people's attention only in the spring, when the return is due, and late fall, when we rush to find the best year-end tax-cutting maneuvers.
Decisions you make between now and the end of the year could make a big difference come April 2005, and you could miss some valuable tax-saving opportunities by waiting until November or December to start the search for tax savings.
Of course, investors should never let the tax tail wag the investment dog in deciding what to buy and sell, and when. But they should not ignore tax issues, either.
Here, then, are a few things investors should remember, according to Bernstein Investment Research and Management or New York, a portfolio manager for wealthy clients:
• Track holdings by tax lot. This means breaking down each of your stocks, bonds and funds according to purchase dates and price. Most investors think of the entire holding as one entity, even if shares were accumulated over time at varying prices.
Profits on shares held for 12 months or less are taxed as short-term capital gains, at rates as high as 35 percent - the same as income. Shares held longer than 12 months are taxed at the long-term capital gains rate, no higher than 15 percent.
• Avoid triggering short-term capital gains tax. The closer you get to that 12-month dividing line, the more sense it makes to postpone a sale until it will be subject to the lower rate. The day before the 12-month period ends, you need a much stronger reason for selling than you did soon after the period began.
Be flexible in applying that rule. Investors who sell just part of a holding accumulated over time often employ a first-in, first-out rule - selling the shares they've owned longest to be sure of getting the lower long-term capital gains rate.
But Bernstein recommends you think about tax in terms of real dollars, not just tax rates. For example, it could make sense to sell a block of shares owned less than a year, rather than a block owned longer.
• Consider delaying a sale until after Dec. 31. If you want to sell a profitable investment already owned for 12 months, waiting until Jan. 1 will postpone the bill until the next tax year. Money you'd otherwise use for paying taxes could thus earn interest or investment profits for up to 12 more months.
• Avoid unnecessary turnover. Buying and selling that does not have a compelling reason triggers taxes, commissions and other "transaction costs" that could be avoided. High turnover can easily reduce your investment performance by 2 to 2.5 percentage points a year. Doing so year after year can dramatically undermine your long-term results.
Beware of willy-nilly tax-loss selling. By selling a money-losing investment, you can harvest a loss that will reduce taxes by offsetting a gain on a winner. But what if you think the loser is likely to rebound?
You can sell the shares and then buy them back 31 days later. That way, you don't run afoul of the "wash-sale" rule that would prohibit taking a loss if shares were bought within 30 days before or after the sale. It's meant to discourage sales done purely for tax savings.
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