By Vita Nelson
The Moneypaper
Wash Sales: Not only can realized losses offset capital gains, but net capital losses can be deducted from your other income, up to $3,000 per year. Therefore, you might want to sell stocks or mutual funds for a year-end tax loss.
However, you must wait at least 31 days to buy back the same security or the loss will be disallowed. If you fear that you will miss a price rise during that interval, consider buying a security that's similar, but not identical. For example, you can sell a bank stock at a loss and immediately buy another bank stock that has performed similarly.
If you sell an index fund at a loss, you can't buy another index fund that tracks the same index (or even an ETF that tracks that index), but you can buy an index fund that tracks a different index. So, if you sell an S&P Index fund, you can buy an index fund that tracks the Russell 1000 Index.
Standard Deductions: Year-end tax planning should include considering the standard deduction, which is $5,350 this year for single taxpayers and $10,700 for couples filing jointly. If your itemized deductions are less than $5,350 or $10,700 this year, take the standard deduction.
If you plan to take a standard deduction, reverse the standard year-end strategy of accelerating deductible expense into the current year-end strategy of accelerating deductible expense into the current year. Instead, defer paying such expense as state taxes, mortgage interest, and charitable donations into 2008, when your deductions might be large enough to make itemizing worthwhile. Following this strategy in alternate years can keep you from wasting deductible expenses.
Itemized Deductions: If you itemize deductions on Schedule A, you'll see a category of miscellaneous itemized deductions. That includes such items as tax preparation, employee business expenses, and investments expense. If all of those miscellaneous items top 2% of your adjusted gross income (AGI), the excess is deductible.
Go over your records to see where you stand now. If you expect you AGI for 2007 to be about $100,000, for example, and you've already spent at least $2,000, you're over the threshold. You can send in checks for all the investment publications, investment software, etc. that you use and deduct them in full.
On the other hand, suppose you have only $1,000 in miscellaneous expenses this year. Wait until January 2008 to pay those expenses. Perhaps they'll wind up helping you to get a deduction for 2008.
Similarly, itemized medical deductions must exceed 7.5% of your AGI. Pay now for eyeglasses, checkups, etc., if you're over the 7.5% mark for the year, or defer until 2008 if you're not.
However, if you're subject to the alternative minimum tax (AMT), medical expenses are deductible only to the extent that they exceed 10% of AGI, while miscellaneous deductions aren't deductible at all. So, check first with your tax pro before accelerating payments for investment or medical expenses.
State and Local Taxes: Paying property taxes (as well as estimated state and local income taxes) in December will be a waste if you're subject to the AMT this year, so find out before you do anything.
Even if you are not subject to the AMT, this strategy will work only if you normally send your property tax payments directly to the tax collector. If you normally include your property tax outlays with your mortgage payments, paying early won't make the taxes deductible for 2007 because of the turnover delay.
Charitable Contributions: When you make charitable donations, don't automatically write checks. If possible, use appreciated securities to fulfill charitable obligations.
Suppose you usually give $2,000 to your favorite charity. If you write a check, you're out $2,000.
Instead, give away $2,000 worth of stock that you bought for, say $500. Considering the $1,500 unrealized gain, and the $225 tax obligation (at a 15% rate) you'd have if you sold, this stock is really worth only $1,775 to you, but you get the $2,000 deduction.
To implement this strategy:
- Call the charity and get its brokerage account number.
- Call your own broker or your mutual fund company and explain what you want to do, providing the account number.
- Follow up by fax to confirm the transaction.
Donor-Advised Funds: If you're making 25 gifts of $200 each to various charities, you probably won't want to go through all the paperwork involved in giving away appreciated securities to each one. Instead, you can make one gift of appreciated securities to a donor-advised fund. You can spread the actual contributions over several years, even though you've take an upfront deduction.
Such funds are offered by many local community foundations, as well as by most major financial firms. Minimums vary but some of these funds will let you open an account for as little as $5,000.
Suppose, for example, you were to give $5,000 worth of appreciated securities to a donor-advised fund in December 2007. You'd get a $5,000 deduction this year. The fund will make the donations according to your instructions in the future.
Equipment Write-offs: If you run a business (even a sideline business), you can use the "Section 179" expensing election. In 2007, you can expense up to $125,000 worth of business property. Thus, if you spend $140,000 on business equipment this year, you can immediately deduct $125,000 whereas the other $15,000 must be written off over several years.
The $125,000 limit applies to taxpayers who purchase no more than $500,000 worth or equipment per year. Above $500,000, you lose the benefit of expensing, dollar-for-dollar.
Even though you buy equipment in December 2007, you won't qualify for a 2007 write-off if it's not installed until January 2008. Conversely, if equipment is placed in service in December, you can take a 2007 deduction, even if you don't pay until next year.
Required Distributions: If you (or a parent) turned 70-1/2 in 2007, the first minimum required distribution from an IRA must be taken by April 1, 2008. The amount you must withdraw will be based on the amount in the account at year-end 2006.
However, your second distribution must take place by December 31, 2008, based on the year-end 2007 amount. If you take two distributions next year, the added income may push you into a higher tax bracket.
Instead, you may want to take one distribution by year-end 2007 and only one distribution in 2008. You tax pro should be able to tell you which method will result in a lower overall tax bill.
Good Money After Bad: When a business in which you've invested fails, you can get a capital loss in the year that your stake becomes worthless. A nonbuisness bad debt (typically, an uncollectible loan) is similarly deductible as a capital loss in the year it becomes entirely worthless. Either way, you need to proceed carefully to get the tax break.
Worthless securities. A worthless security must have absolutely no value. Even if it has a token value, you can't claim a capital loss. Therefore, you should sell it to an unrelated party for a nominal amount. If you've invested $5,000 in a cousin's Internet startup that went under for example, sell your shares in the company to a neighbor for $1. As long as you complete the sale before December 31, you can claim a capital loss for 2007.
Nonbusiness bad debts. Again, act before year-end to demonstrate that a debt has become worthless. Document your efforts to collect. If you simply forgive a bad loan, that will make it a potentially taxable gift instead of a deductible bad-debt write-off.
Roth-IRA Conversions: If you are interested in converting a traditional IRA to a Roth IRA, you should withdraw funds from the traditional IRA by the end of the year. The advantage of a 2007 conversion is that it starts the Roth IRA clock at January 1, 2007, even if the conversion is at year-end.
You must be at least 59-1/2 years old to take tax-free withdrawals from a Roth IRA after five years, which means after January 1, 2012. This technique gives you one of those five years right away.
A Roth IRA conversion will be valid only if your income this year is no more than $100,000. Even if you're unsure about your income, go ahead and convert anyway. If you're over the limit, or if you change you mind for any reason, you have until October 15, 2008, to reverse the conversion with no penalty."
Editor's Note: Vita Nelson is editor of The Moneypaper, 555 Theodore Fremd Ave., Ste. B-103, Rye, NY 10580, 1 year, 12 issues, $135. www.Directinvesting.com.
