Mutual funds benefit from the long-standing belief that they allow investors to diversify their holdings without buying individual stocks. But to the unwary investor, tax surprises abound. From a tax planning viewpoint, here are some great mutual fund tips. Most of these tips assume your mutual fund investment is not in a retirement account (like a 401(k) or traditional IRA), unless otherwise noted.
Maximize Your Mutual Fund Investments
As the year comes to an end, there are several tax-saving ideas you should take into consideration. Use this checklist to ensure you don't miss an opportunity before the year is over.
Although the markets have been up a lot this year, your investment portfolio could have a few lemons in it. Using the tax strategy of tax-loss harvesting, you may be able to turn those lemons into lemonade. Here are five tips:
1. Separate Short-Term and Long-Term
Your investments are divided into short-term and long-term buckets. Short-term investments are those you've owned a year or less, and their gains are taxed as ordinary income. Long-term investments are those you've held more than a year, and their gains are taxed at lower capital gains tax rates. A goal in tax-loss harvesting is to use losses to reduce short-term gains.
Example: By selling stock in Acme, Inc., John Smith made a $10,000 profit. John only owned Acme, Inc. for six months, so his gain will be taxed at his ordinary income tax rate of 35 percent (versus 15 percent had he owned the stock more than a year). John looks into his portfolio and decides to sell another stock for a $10,000 loss, which he can apply against his Acme, Inc. short-term gain.
2. Follow Netting Rules
When you’re tax-loss harvesting, use IRS netting rules on the realized gains and losses in your portfolio. Short-term losses must first offset short-term gains, while long-term losses offset long-term gains. Only after you net out each category can you use surplus losses to offset other gains. Use this information to your benefit to reduce your taxable income when selling investments.
3. Offset $3,000 in Ordinary Income
In addition to reducing capital gains tax, excess losses can also be used to offset up to $3,000 of ordinary income. If you still have excess losses after reducing both capital gains and ordinary income, you can carry them forward to use in future tax years.
4. Beware Wash Sales
The IRS forbids use of tax-loss harvesting if you buy a "substantially similar" asset within 30 days before or after selling it. Plan your sales and acquisitions to avoid this problem.
5. Consider Administrative Costs
Tax-loss harvesting comes with costs in both transaction fees and time spent. Reduce the hassle by conducting tax-loss harvesting once a year as part your annual tax-planning strategy.
Remember, you can turn an investment loss into a tax advantage, but only if you know the rules.
When a person sells a capital asset, the transaction usually results in a capital gain or loss. Capital assets include inherited property or belongings someone owns for personal use or as an investment.
Here are 10 facts you should know about capital gains and losses:
Have a question about capital gains or losses? Give Ellsworth & Associates a call at 513.272.8400. We would be happy to help.