Deductions may help ease investment losses
For the Appeal
It’s no secret that 2007 wasn’t a particularly good year for investors. A difficult environment for equities, heavy losses on some types of fixed-income securities – particularly those related to sub prime mortgages – and broad-based declines in residential property prices all combined to leave may investors nursing significant portfolio damage.
Now, courtesy of Uncle Sam, those investors may be able to get at least some of that money back by deducting their losses on their tax returns.
However, many won’t be able to take full advantage of these breaks because they didn’t have an effective tax-reduction strategy in place last year. A strategy that would have allowed them to make the best use of their capital losses now.
Moral of the story: Tax planning shouldn’t be left until the end of the year, or worse, until you sit down to fill out your 1040 form.
Investors need to understand the tax implications of their decisions ahead of time, and they ideally should have a system in place for efficiently matching capital losses against capital gains and, where applicable, ordinary income.
However, developing a successful tax strategy can be a complex business. Many factors influence the size and timing of tax liabilities, such as the kinds of assets that are held in a portfolio, how long those assets are held and whether losses on one asset can be used to offset taxable gains on another.
Investors should recognize also that differing tax rules might apply to different types of income and losses, including those stemming from so-called passive investments – a category that frequently includes limited partnership interests and rental real estate holdings. These rules may limit their ability to deduct losses on those assets.
Likewise, investors should realize that how they invest could be as important as what they invest in. Different investment vehicles are not given the same treatment under tax law.
Some types of accounts may offer greater flexibility than others to control the timing of tax liabilities.
Tax planning is a complex and highly personal process, and investors shouldn’t rely on this article for their own planning needs. They should consult a qualified tax professional, such as a certified public accountant or a tax attorney.
That said, however, the following discussion may help investors as they begin to think about how to improve their investment strategies and better manage their tax liabilities in 2008.
Taxes are still the largest single investment cost for many individual investors, despite a hefty round of tax cuts in 2001 and another in 2003. On the plus side, the top federal rate on most long-term capital gains has been reduced to just 15 percent and in 2008 will fall to zero for taxpayers in the 10 percent and 15 percent federal income tax brackets.
In addition, most stock dividends now are taxed at the same low rate as long-term capital gains.
The top federal tax rate on ordinary income, including salaries, wages and interest income, has been reduced also, but not nearly as much. The combined federal, sate and local tax burden still can equal 40 percent or higher in some jurisdictions.
The same goes for short-term capital gains (profits on assets held for less than a year), which are taxed at the same rate as ordinary income.
Now for the really bad news: The rate reductions all are scheduled to “sunset,” or expire at the end of 2010.
There is no guarantee Congress will renew them. If it does not renew, the long-term capital-gains rate will revert to 28 percent, and the top federal rate for ordinary income (including dividends) and short-term capital gains will return to a maximum 39.6 percent.
Fortunately, there are ways to reduce investment taxes that don’t depend on the kindness of Congress. That’s because for most portfolio assets, such as stocks and bonds, investors can use their realized losses dollar for dollar to offset taxable capital gains.
Typically, first short-term losses are matched against short-term gains, then long-term losses against long-term gains and finally the net short-term loss, if any, against any net long-term gain. Capital losses in excess of gains can be used also to shelter up to $3,000 a year in ordinary income, or carried forward and used to shelter gains or income in future years.
Managing tax liabilities is crucial to long-term financial success. For this reason, investors need to consider all or the many tax aspects of their chosen investment strategy and understand the advantages and disadvantages of using different investment vehicles.
By working closely with qualified tax and financial advisors, investors can develop the investment plan that best suites their specific tax situation.
Of course, even the most effective tax-management techniques won’t give your portfolio total protection from market downturns, but they may help at least cushion the blow. I would be happy to provide more information about the investment products and services that may help you manage your tax liabilities more effectively.
For more information, e-mail firstname.lastname@example.org or call 689-8700.
Smith Barney does not provide tax and/or legal advice. Please consult your tax and/or legal advisors for such advice.
• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas Street, Suite 200, Reno, NV 89509.