Got Losses? Use Them or Lose Them
As 2011 draws to a close, time is running out to make any tax-saving moves in your portfolio. While we caution against letting the “tax tail wag the portfolio dog,” you may want to consider taking advantage of the opportunity to trim your taxes by “harvesting” tax losses on mutual funds you own in taxable accounts. Of course, if you own your funds in tax-advantaged accounts, such as IRAs, there is no need to worry about tax-loss harvesting.
By harvesting, we’re referring to offsetting any capital gains you incurred in 2011 by selling funds (or particular share lots) that have lost value since your original purchase. Short-term gains are subject to ordinary income tax rates, which can be as high as 35%.
Losses can also be used to offset ordinary income, but only up to $3,000 per year. Any losses not used this year can be carried forward to future years.
As you consider your tax-planning options, however, be aware of the wash-sale rule. This rule is designed to prevent investors from temporarily selling shares to gain a tax advantage and then repurchasing them a short time later.
Under the wash-sale rule, you lose the ability to claim a tax loss if you make a purchase of the same fund (or a substantially similar fund) 30 days prior to or 30 days after a sale. Therefore, if you sold 100 shares of XYZ fund on December 15 at a loss and bought the shares back on January 3, 2012, you could not claim a capital loss. The same rule would apply if you bought shares on November 15 and sold them on December 12. These rules apply whether you made a direct purchase or reinvested a fund distribution.
Assuming you abide by the wash-sale rule, harvesting tax losses can be a cost-saving aspect of your investment strategy. That said, you should also be careful not to sell shares of a fund you won’t be able to replace. For example, if a fund is closed to new investors and you sell all of your shares, you won’t be able to buy back in. Before you make any moves, we recommend speaking with a trusted professional tax advisor.
What Do the New Cost-Basis Reporting Rules Mean for You?
Starting in 2012, your brokerage firm will have a little something extra for you come tax time. Thanks to the 2008 Emergency Economic Stabilization Act, which also brought us the Troubled Asset Relief Program (TARP), brokerage firms will be required to report the adjusted cost basis and gross proceeds for any individual stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. acquired after January 1, 2011 on IRS Form 1099-B. These changes are designed to ensure investors accurately report gains and losses on the sale of securities.
If you invest exclusively in mutual funds, you won’t see this new information on your 1099-B this time around. However, also starting in 2012, the IRS will require brokerage firms to start tracking cost basis on mutual funds and certain ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. acquired on or after January 1, 2012. This information will be reported on form 1099-B in 2013, and it will include details on cost basis, holding period, acquisition date and disallowed losses from a wash sale.
Under the new rules, the default method for brokerage firms to calculate cost basis on mutual funds is first-in, first-out. However, investors can designate an alternate disposal method, such as last-in, first-out, highest cost, or lowest cost. You can set up a default method or choose specific methods for specific tax lots. However, once a trade settles, the method cannot be changed.
For existing positions tracked by your brokerage firm using average cost, purchases of new shares after January 1, 2012 will be recorded separately from shares purchased previously. Brokerage firms will be required to track and report covered and non-covered average cost shares as two separate positions, each with its own average cost. This “bifurcated” average cost will be used to calculate the gain/loss amount on Schedule D and will be reflected on your 1099-B for the sale of covered shares.
So what does this all mean for you? To start, you’ll have more information at your disposal come tax time to help you accurately report investment gains and losses on your return, which will save you the effort of tracking it down yourself, and brings the potential for increased savings. Of course, the catch is that your brokerage firm will be reporting this same information to the IRS, so you’ll need to make sure that what you submit on your return matches what is sent to the tax man on your 1099-B–if it doesn’t, you may be getting some unwanted attention and even paying some penalties down the line. As with tax-loss harvesting, if you have any questions about the new 1099-B and how to use the data provided when filling out your return, it behooves you to talk to a tax professional.
Vanguard Distribution Calendar
As we reported two weeks ago, many mutual funds pay out accumulated income and/or capital gains each year in December. This income is taxable in the year it is received, as are any capital gains distributions you receive from funds held outside of a tax-advantaged retirement account.
Any shares you own on the fund’s “record date” will be eligible for distributions. To avoid taxable distributions just before the end of the tax-year, avoid buying a new fund, as well as additional shares in an existing fund, until after the record date.
To help you avoid this mistake, we provided an alphabetical list of Fidelity funds scheduled to pay out income and/or capital gains in December, which you can see by clicking here. We also promised to provide complete information on Vanguard funds and ETFs when it became available, which you can see below:
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Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
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