Consider recognizing capital gains this year

Tax cuts enacted by the Bush administration nearly a decade ago are set to expire at the end of the year, creating uncertainty – as well as opportunity – for investors looking at year-end tax planning strategies.

If the cuts expire without Congressional action, virtually all taxpayers will see an increase in federal income taxes next year. Given what we know now, choosing to recognize a capital gain this year instead of next may make sense for some investors.

The top tax rate for long-term capital gains in 2010 is 15 percent, and there is no tax on gains for couples with income below $68,000 (single taxpayers below $34,000). Those rates are scheduled to increase to 20 percent and 10 percent, respectively, for long-term gains realized after 2010. President Obama proposed maintaining the current rates for most taxpayers, while raising the rate to 20 percent for couples with income over $250,000 (singles over $200,000). However, no legislation has been introduced yet.

This means that, at best, some taxpayers will see capital gain rates that are the same in 2011 as in 2010. However, higher-income taxpayers, and possibly all taxpayers, could be facing larger taxes on capital gains next year. Therefore, if you are considering recognizing a gain in either 2010 or 2011, it appears 2010 is the better option from a tax standpoint. Before you do that, though, you should understand the investment implications.

While taxes are an important aspect of managing a portfolio, the impact of portfolio changes should be the primary concern. If you have investments with a low cost basis or a short horizon before you plan to sell (assuming the tax stays at 20 percent in the future), the investment return needed to offset the additional tax increases. In other words, the larger the gain you currently have or the shorter the time horizon for selling the stock, the better off you might be by selling in 2010 under the current tax structure.

The uncertainty surrounding current tax law is unlike anything we’ve seen in recent memory, so it pays to follow closely what Congress does over the next few months.

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