Time is running out and I have to make a difficult decision… whether to sell my long term capital gains for a potential tax savings down the road or not. Yes, you read that right. I'm considering selling my winners to save tax money down the road. And for those of you in roughly the same situation as me, it may be an option you have not considered.
This article isn't going to be for everyone. If you don't live in the United States, you aren't going to give two toenail clippings on how to take advantage U.S. federal tax laws. If you aren't in the 15% tax bracket or have taxable assets, this won't be immediately applicable to you either. Still, it may serve you well down the road.
But enough with the disclaimer. The article will be short and sweet. Just take the time to read it already.
Bottom Line up Front
Currently, I have two upcoming developments which may shift me out of the 15% tax bracket and into the 25% tax bracket in 2014. I have several equity positions which I've held for several years, and which have netted me capital gains. If I stick with a few of them, I could sell them and book long term capital gains without raising my federal income above 15%. By remaining within the 15% tax bracket, I can immediately re buy my positions, and reset my taxable cost basis on these positions. My total federal tax on those positions would be a whopping $0.00.
Yes. That's right. Wash Sale rules do not apply to profits. And for some of you (maybe many of you), I'm sure this is completely obvious. But for me, it was somewhat a revelation, when I thought about it one day. I have always been focused on culling through my losers to find those I want to shed to lower my tax base. I never thought about instantly resetting my tax base to take advantage of my current tax bracket. For more information, please review IRS publication 550 here, or read this simplified version here.
So here's a concrete example. If things develop as I hope in 2014, I will be in the 25% tax bracket. Three potential candidates are Microsoft (NASDAQ:MSFT), Finish Line (NASDAQ:FINL), and Silver Wheaton Corp (SLW). The combined positions would net me $3735.16 in capital gains if I sold right now. My total in and out costs would be $30 in trading fees. But by buying and selling right now, I could save (potentially) $560.27 in federal taxes. Since long term capital gains rates are 0% for those in the 15% tax bracket, I'll pay nothing on current gains. Moreover, if any of these positions move south after today, I could take a tax loss down the road while pocketing a return on my investment. I like the sound of that… but as always, it isn't so simple.
Federal Tax isn't the only Tax
I have the (sometimes dubious) honor of being a California resident. For those of you in states without income taxes, this technique is almost without penalty. For me, there is a 4% tax I will be incurring on these positions, and I like to put off paying taxes as long as possible. So, I look to pay $178.80 (that's $3735.16- $15.00 in brokerage fees x 4% +$30 in commissions) for a potential savings of $560.27. Not a bad tradeoff at all, if I end up with the new job. But there are a couple of other considerations we should keep in mind:
- Slippage costs. The bid/ask spread on these stocks should be about a penny difference, but you may pay substantial amounts to move shares in less liquid positions.
- There is always a danger that the markets will move substantially (and disadvantageously) between the time your sell and buy orders are executed.
- By selling now, you are converting a long term position into a short term position. If the price suddenly shoots to the moon over the next few months, and you feel you need to sell the position because it's unreasonably overpriced, your attempt to save money down the road may actually raise your future tax liability. For instance, if my three stock positions were to gain an additional $4000 in value, they would almost certainly be overpriced, and I'd be very tempted to sell them, or at the very least issue rolling stops on them. But if the positions were liquidated, and I was in the next higher tax bracket (25%), I'd now have the privilege of paying $1000 of short term capital gains taxes. Add in the $178.80 I spent to refresh the taxable cost basis, and I'm out $1178.80 vs. the alternative of paying long term capital gains of $1160.27 if I hadn't rolled the cost basis.
Despite the costs and risks, rolling my cost basis up may be well worth it for me in the long run. The most important thing to do when making this decision and any investment decision really, is to chart out your specific risks and costs and determine if the course of action is still worth taking. For me, the biggest risk is that I will remain in the 15% tax bracket, and may even move out of California. I will have spent the $178.80 needlessly, and if I sell in 2014, my decision may cost me even more money.
I hope some of you are able to take advantage of this article to save on your taxes in the coming years. Happy New Year.
Disclosure: I am long MSFT, FINL, SLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a tax professional. The article is meant to step through logical steps I'm taking in my own tax planning. If you have any doubts or concerns with the discussed strategy, you should discuss it with a licensed tax professional.