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Tackle taxes: Got gains or losses?

A strong year for stocks and higher taxes on gains make tax-loss harvesting important.

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With stocks up strongly this year, odds are you have some nice gains in your portfolio. But that may mean a higher capital gains tax bill too, especially for upper-income investors, because of higher tax rates that took effect in 2013. So it is important to take the time to review your portfolio to see if there are any tax losses you can harvest to offset realized taxable gains and lower your 2013 tax bill. Remember, you need to act by December 31.

Tax-loss harvesting, or selling investments such as stocks, bonds, and mutual funds that have lost value, can reduce the tax liability on capital gains realized from winning investments. And, this year, harvesting losses could be an even more attractive strategy for high-income investors. That’s because of three tax increases that took effect in 2013:

  • The highest tax rate on long-term capital gains increased to 20% from 15%;
  • A new 3.8% Medicare surtax for high-income taxpayers pushed the highest effective long-term capital gains tax to 23.8%; and
  • The top tax bracket is now 39.6% for ordinary income, nonqualified dividends, and short-term capital gains. The previous top rate was 35%. With the Medicare surtax, the effective rate can now be as high as 43.4%.

Even if you won’t be hit by higher rates, tax-loss harvesting can still be an effective tax strategy, potentially helping to reduce the costs of rebalancing, which is needed to ensure that your investment mix (i.e., stocks, bonds, and short-term investments) is aligned to your investment time frame, financial needs, and comfort with volatility.

How much can you save?

The size of the potential benefit from tax-loss harvesting for 2013 depends on two key factors: your income level and the amount of short- and long-term capital gains, net of any current losses that you may have realized this year or any losses carried forward from other years.

Short-term capital gains are those realized from investments that you have held one year or less, and they’re taxed at the marginal rate you pay on ordinary income. The new top marginal tax rate on ordinary income is 39.6%. It applies to couples filing jointly with income above $450,000, and single taxpayers with income above $400,000. If subject to the Medicare surtax, the effective rate can be as high as 43.4%.

Long-term capital gains, those realized from investments held for more than a year, are taxed at significantly lower rates. You won’t owe any long-term capital gains tax if your 2013 income was below $72,500 and you are married filing jointly or $36,250 and you are a single filer. For the majority of taxpayers—those with income between $72,501 and $450,000 (married, joint filers) and $36,251 and $400,000 (single filers)—the long-term capital gains rate will remain at 15%.

High-income taxpayers, on the other hand, will be subject to higher rates. If your income is more than $450,000 (married joint filers), or $400,000 (single filers), your marginal rate for long-term capital gains will be 20%.

However, the new 3.8% Medicare surtax means that the actual long-term capital gains tax for high earners can be as high as 23.8% and the actual rate applied to other investment income as high as 43.4%. The surtax is levied on the lesser of: (1) net investment income, or (2) the amount by which modified adjusted gross income (MAGI) exceeds $250,000 for couples filing jointly and $200,000 for single filers. 

For example, a couple with MAGI of $270,000 of which net investment income accounted for $50,000 would owe the 3.8% surtax on $20,000 (the amount by which their MAGI exceeded the $250,000 threshold, which is less than the $50,000 in net investment income). If the couple had $330,000 in MAGI of which $50,000 was net investment income, they would pay the surtax on $50,000 (the amount of their net investment income, which is less than the $80,000 excess of their MAGI over the $250,000 threshold).

Prioritizing your tax savings

To help maximize your tax savings, you should apply as much of your capital loss as possible to short-term gains, because they are taxed at a higher marginal rate. This is particularly true for high-income investors.

For example, if you’re in the top tax bracket, the rate spread between short- and long-term gains can be as high as 19.6% (43.4% versus 23.8%). However, if you’re in the 25% bracket for taxable income—$72,501 to $146,400 for joint filers and $36,251 to $87,850 for singles—the spread between the short- and long-term gains rate is 10% (25% versus 15%).

The tax code requires that short- and long-term losses be used first to offset gains of the same type. But if your losses of one type exceed your gains of the same type, then you can apply the excess to the other type. For example, if you were to sell a long-term investment at a $15,000 loss but had only $5,000 in long-term gains for the year, you could apply the $10,000 excess to any short-term gains.

Realizing a capital loss can be effective even if you didn’t have realized capital gains of either type this year. The tax code allows you to apply up to $3,000 a year in capital losses to reduce ordinary income, which is taxed at the same rate as short-term capital gains and nonqualified dividends. If you still have capital losses after applying them first to capital gains and then to ordinary income, you can carry them forward for use in future years.

The least effective implementation of a tax-loss harvesting strategy, on the other hand, would be to apply short-term capital losses to long-term capital gains. But, depending on the circumstances, that may still be preferable to paying the long-term capital gains tax.

Keep in mind

Don’t allow a desire to lower your current-year tax liability to drive a decision that might undermine the longer-term goals of a diversified investment portfolio. A tax-loss harvesting strategy should always align with your overall investment strategy. Good candidates for tax-loss harvesting are depreciated investments that no longer fit your strategy, that have poor prospects for future appreciation, or that can be replaced by other, equally attractive, investments that are similar (but not exact matches) to the ones you are considering selling.

It is possible to sell a depreciated asset that you still want in your portfolio by investing the proceeds from the sale in another asset that is not “substantially identical” (as defined by the IRS), then selling that and buying back the original investment more than 30 days after the sale date. If you repurchase the asset too soon or invest in something the IRS deems substantially identical to the original security, such as a call option on it, the IRS “wash sale” rule will generally disallow the loss deduction. There’s also a risk that the substitute asset you buy will increase in value during the 30-day waiting period, and you’ll realize a short-term gain if you sell it. On the other hand, if the substitute does not rise in price over the 31-plus-day period, but the original asset does, you may miss out on some of the appreciation.

If you want to maintain exposure to the industry of the stock held at a loss, you might consider using an exchange-traded fund (ETF) as a substitute following a tax-loss harvest sale. Read Viewpoints: Tax-loss harvesting using ETFs.

What to do now—and next year

If you plan to implement a tax-loss harvesting strategy to offset a portion of your gains, be sure to research your records carefully on any asset you are considering selling. You’ll want to be certain about the cost basis of your depreciated asset—which will determine the extent of your loss—before you make your move. To check the amount of capital gains and losses in your nonretirement Fidelity accounts—and determine whether they’re short or long term—log on to and go to Accounts & Trade > Portfolio > Select Action > Tax Info (Year-to-Date).

Also, take some time to determine how changes in the value of your investments within your portfolio have affected your asset mix. Routine portfolio rebalancing to offset shifting asset values is recommended for keeping your portfolio aligned with your goals. It often provides an opportunity to reexamine lagging performers that could be candidates for tax-loss harvesting.

Ideally, tax planning should be a year-round activity, and that includes tax-loss harvesting. Keeping good records will help you track your cost basis and anticipate any significant capital gains tax liability long before the end of the year, when your options may be more limited.

Also keep in mind that selling a depreciated investment that no longer has a place in your portfolio can be a good move even if you don’t anticipate having capital gains to offset it. You can use the proceeds to invest in something with better prospects that may better suit your needs. The loss can be used to lower your tax bill through reducing ordinary income by $3,000 or carried over into future years if not needed immediately.

Learn more

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The tax information and estate-planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide estate planning, legal, or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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1. The Fidelity® Personalized Portfolios service applies tax-sensitive investment management techniques (including tax-loss harvesting) on a limited basis, at its discretion, primarily with respect to determining when assets in a client’s account should be bought or sold. Because it is a discretionary investment management service, any assets contributed to an investor's account that Fidelity® Personalized Portfolios does not elect to retain may be sold at any time after contribution. An investor may have a gain or loss when assets are sold.
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