2012-2013 Fiscal Cliff Tax Strategy
As I write this, there is still no agreement between the President and Congress over a budget deal for 2013.
Gee, now there’s a surprise! Who could’ve predicted this??
Okay, humor and politics aside, no matter what agreement they reach, there are steps you can and should be taking right now to prepare yourself for one key area of the budget where you still retain some control: Capital Gains Tax Rates.
The one thing we already know is that tax rates on capital gains and investment income are going up in 2013 by 3.8% due to a provision in the Patient Protection and Affordable Care Act (i.e. Obamacare). As of today, this will apply to joint filers above $250,000 and single filers of $200,000.
What we don’t know yet is whether capital gains tax rates will also go up from 15% to 20%, or even higher.
Given this, I don’t recommend buying or selling anything yet, but I do recommend preparing for the announcement by doing some homework.
Before I share my recommendation, let’s quickly review capital gains tax law for a moment so we can clarify where this opportunity lies for you.
Capital Gains Tax Law
As a refresher, for investments you currently own outside of IRAs (you don’t pay capital gains when you buy and sell investments inside your IRA), all “realized” gains are taxed at capital gains tax rates.
For example, if you purchased a stock or stock mutual fund for $100,000 and later sold it for $150,000, you would owe capital gains taxes on the growth, i.e. $50,000.
On the flip side, however, if you purchased a stock or stock mutual fund for $100,000 and later sold it for $80,000, you can declare a capital loss of $20,000.
That $20,000 capital loss, while painful to realize, has significant value if handled properly. For example:
An Opportunity From the ‘Dog Days’ of 2008-2009
Had you sold any investments during the downturn in 2008/2009, thus locking in and ‘realizing’ a capital loss, you now have the opportunity to recover some of your losses.
Or, if you have any investments held outside of IRAs that are currently in the red since you purchased them, you have an opportunity to lock in a capital loss right now and use it against your realized gains this or next year.
** The key point to grasp is that, if capital gains tax rates go up next year, any losses you had in the past that you’re carrying forward will be worth MORE to you next year.
So, if rates are definitely going to go up, carry your previously realized capital losses forward to use in 2013.
Here’s why: if you have $20,000 of capital losses that you’ve carried forward from prior years and you use them to offset $20,000 of capital gains in 2012, you save $3,000 in capital gains taxes.
However, if capital gains tax rates go up next year to 20%, and you’re also subject to the medicare surtax I mentioned above, thus increasing your capital gains tax rate to 23.8%, that same $20,000 capital loss will save you $4,760 instead of only $3,000!
Fiscal Cliff Capital Gains Tax Strategy
So you can be ready, my recommendation for you is three-fold:
Once you’re armed with this information, now you’re ready to ACT when the President and Congress reach an agreement.
Remember that it’s your “net” investment returns (after taxes) that you get to spend! Paying more than you’re legally obligated to pay is not an act of patriotism. It’s laziness!
Take control in places where you still can!
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