Year-End Planning: Focusing on Your Investments
With 2007 winding down, you still have several opportunities to manage your investment-related tax liability for the year, keeping your overall financial objectives in mind. Below are some important points to keep in mind.
Look before you leap into a mutual fund. Thinking about buying a mutual fund before 2007 runs out? If you plan to hold the fund in a taxable account, find out what capital gains distributions, if any, you can expect to receive from the fund this year if you do invest before December 31. Many funds distribute the year’s capital gains, reflecting the fund’s net profit from selling stocks or other holdings, to shareholders in December. Buying into a fund just in time to receive a distribution might sound like a good idea – until you realize a couple things.
First, the distribution will not boost your return, because it will reduce the fund’s assets, causing the share price to fall by the same amount that was distributed per share. For example, a distribution of $1 per share will trigger a corresponding $1 drop in the share price, leaving you with the same amount of assets you had before the distribution.
Second, you will owe tax on the distribution. This isn’t so bad in a situation where you’ve been in a fund long enough to see your investment appreciate. But if you receive a distribution only a day or so after buying a fund, typically, you will end up owing tax on gains that occurred earlier in the year, before you were even in the fund. Why pay tax on gains that benefited other investors but not you? In fact, some year-end distributions will be unusually high this year, due mostly to the overall strong performance of the stock market during the past several years. This could mean a particularly high tax bill for you next April.
Consider using losses to offset gains. You can reduce a capital gains tax liability by selling investments that have declined in value. Losses on investments can be used to offset gains on other investments. If your combined losses exceed your combined gains, you can deduct up to $3,000 ($1,500 if you’re married and filing separately) of capital losses against regular income.
Be tax-savvy when donating securities to charity. Are you interested in donating securities to a charitable organization? If you’ve held the securities for longer than one year and they’ve appreciated, donate the securities, rather than the cash proceeds you’d get from selling them, to a charitable organization. That way, you’ll be able to deduct the securities’ fair market value, plus you will not incur any tax on the appreciation. However, if the securities you’d like to donate are worth less than your cost, generally, you’ll be better off selling them and donating the proceeds, because this will enable you to recognize a capital loss.
You may want to consider using a donor-advised fund to make charitable contributions. You make an irrevocable contribution – of cash or appreciated securities – to a donor-advised fund and receive a tax deduction in the year of your contribution. Then, you direct the fund to make gifts on your behalf to charitable organizations of your choosing (provided they’re IRS-qualified charities). You control the timing of gifts.
At Grand Wealth Management, we help our clients make smart investment decisions and save on taxes – not only at year-end, but all year and every year for the long term.