As you know, long-term capital gains rates are currently taxed at the 15% on the Federal level. As it stands right now, the rate is scheduled to reset to 20% on January 1, 2013. In other words, capital gains taxes are on sale by 25% right now compared to next year – or alternatively speaking capital gains are expected to be 33% more expensive next year. You may have also read that there is a tax on ‘unearned income’ next year to help pay for the Affordable Care Act (more prominently known in the media as ObamaCare). This tax only impacts married couples filing jointly with adjusted gross incomes (AGI) in excess of $250k and individual filers with AGI over $200k.
With that being said, there is a clear opportunity to capture some – or all – of your long-term capital gains this year at the 15% rate rather than paying 20% in a year or two. The process would be rather simple, sell the position with the long-term capital gain today and repurchase it tomorrow. You do not have to worry about the 30-day wash rule because it only applies when you are selling losses (i.e., the government only cares about you taking away revenue not when you are accelerating income to them).
What are the potential downsides to this strategy?
1) The first and most obvious is that the capital gains rate may not rise for everyone – or even anyone. No one knows where this is going to end up and taking the gain is a risk. However, the Administration has advocated for a 20% capital gains rate across the board since its campaign in 2008 so I think that is where it ends up.
2) The other clear risk is that you sell the position today and then repurchase it tomorrow. Afterwards, the position does really well and you sell the position in mid-to-late 2013 for a more attractive position. This means that you have converted the future gains to short-term capital gains (taxed as ordinary income) rather than long-term capital gains. Depending on the percentage gain in the position and your ordinary income next year, this could completely wipe out the benefit of selling today at the long-term capital gains rate rather than waiting until next year.
3) You could also sell positions this year and recognize a gain of $X and immediately repurchase it. Afterwards, the country falls into a recession – for any number of reasons – and then you subsequently lose all the gains that you ‘would have had if you hadn’t sold the position’ AND then you sell it to reposition it. In other words, we run the risk of paying taxes on gains that you recognize only for tax purposes and not for your own economic benefit.
A couple of other thoughts about the year-end discussions right now are:
1) You would prefer NOT to sell any capital losses from now until the end of the year. The reason is the exact opposite of the decision to accelerate capital gains into this year. Capital losses will offset capital gains taxes next year at the 20% rate rather than the 15% rate this year. In other words, capital losses should be 33% more valuable next year.
2) It does not have to be an all or nothing strategy. You can ‘cherry pick’ a few positions that you think would be good candidates to sell.
3) This isn't an exclusive decision for people. There are many different tax strategies to be implemented this year. Accelerating capital gains into this year impacts the decision to do Roth conversions at 'favorable rates'. There are also impacts to Medicare Part B premiums if you increase your income over certain thresholds. Any time you increase your income, you are also impacting your current year tax strategies. In other words, no tax decision is made in isolation and should be made with your accountant or tax professional.
