It's Harvest Time - for Tax Losses

2015 has been a volatile year for the stock market. With big dips in the spring and fall you have ridden the roller coaster of investing.

One area taking a huge hit this year was oil and gas. The energy sector was down more than 40% over 2014. Perhaps you have a few energy stocks that show losses - the current value is less than what you paid for them. Or maybe, a "hot tip" from a friend did not pan out well.

This would be the time to review your portfolio and sell any losers. You may write these losses off against any capital gains you've made during 2015, dollar for dollar.

For example - you bought an oil company stock three years back and now it's worth half that amount giving you a $5,000 loss.
Earlier this year you had a winner; you sold a bank stock that doubled going from $5,000 to $10,000 giving you a $5000 capital gain. If you sell the losing oil stock and capture the $5,000 loss you may offset the $5,000 capital gain with the $5,000 capital loss and owe no taxes on the capital gain.

Tax-loss harvesting is a strategy that enables investors to save on their tax return by selling losing securities and using the capital loss to offset their gains. You may take advantage of this strategy in your year-end tax planning.

BUT if you want to buy another oil company stock to replace the one you sold, you should not buy a stock that is "substantially identical” to the one you have sold. The IRS considers this a "wash sale" and will disallow the tax loss. You must replace that oil company stock with an energy company that is substantially different.

Say you realized no capital gains this year, then you may take $3000 of the capital loss against $3,000 of ordinary income. The remaining $2,000 may be carried forward and used against 2016 taxes.

Please call your tax adviser to determine if this strategy is right for you!

Be $ Smart - review your portfolio; sell losing stocks and reduce your taxable income.

Minimize your taxes

It makes sense to find ways to reduce your taxable income. One place to start is your portfolio. Your investments generate a certain amount of taxable income each year as witnessed by the number of 1099's you receive in the new year.

If you want to reduce the taxes generated by your portfolio, put the big tax generating investments in your tax-deferred retirement accounts - IRA, Roth IRA and 401k. These include real estate investment trusts (REIT's), taxable bonds and actively managed mutual funds (which usually have high, annual portfolio turnover).

Put stocks and stock indexed mutual funds in your taxable accounts where you will be happy holding them for 12 months or longer. After 12 months, they are taxed as long-term capital gains not as ordinary income, a much lower rate. If you pass this account on to your heirs, they could pay virtually no capital gains tax when they sell.

Be careful as you reconfigure your portfolio. Do it slowly and methodically. If you sell too many investments with gains in any given year in your taxable accounts you may increase your tax obligation and push yourself into a higher tax bracket. Best to consult your account first.

Be $ Smart - re-position your investments to minimize your taxes.

Another Type of Diversification

Over the past few weeks we have talked about diversification within your portfolio. We use diversification to reduce potential risk. Another kind, tax diversification, occurs with the types of accounts in which you hold your assets and how withdrawals are taxed.

No matter how you make your money, Uncle Sam is waiting to take his share. You can structure withdrawals to be tax efficient and lower your tax burden. This is especially effective during retirement. For you to have income choices you must build these accounts prior to retirement, while you are young and in the "accumulation" phase of your life.

A well diversified portfolio will hold a mixture of assets - stocks, bonds, cash, real estate, precious metals, etc. Creating a tax-diverse portfolio means you hold assets in taxable, tax-deferred and tax-free accounts.

A trained advisor will scrutinize a retirement plan for tax efficiency. You want to minimize taxes by taking income from specific accounts.
Remember, money held in tax-deferred accounts (traditional IRA, 401k,etc.) is fully taxed as ordinary income on withdrawal paying both state and federal taxes.

If all your assets are tax-deferred, every withdrawal will count as income and could push you into a higher tax bracket. For example, say you need $60,000 a year for income, you must withdraw $72,000 to cover the 20% withholding. Add that to Social Security or pension income, you could bet bumped into the next tax bracket. But, if you could take $40,000 ($48,000 less 20%) from the IRA, $10,000 from your taxable account(paying some capital gains tax) and $10,000 from your Roth (tax-free), you maintain a lower taxable income.

Be $ Smart - build your savings in different types of accounts for tax efficiency.

Be sure to consult your tax advisor for specifics.

Investment Diversification cont'd - Cash

In previous weeks we talked about the various ways to diversify your money among stocks and bonds. A third component of spreading your money is CASH. It is important to keep a percentage of cash on hand for various reasons:

- safety - the value stays reasonably consistent,

- liquidity - it's available with no hassle when you need it,

- opportunity - when a time to enhance your portfolio comes along the money is available to buy more stocks or bonds,

- emergency - with an ample cash cushion you won't run up credit card debt incurring huge interest charges.

Other than stuffing the cash into your mattress or hiding it in a coffee can in your closet here are a few places to keep your cash:

- plain old-fashioned bank savings account (FDIC insured),

- short-term bank CD (certificate of deposit) (also FDIC insured) where you have immediate access if you are willing to incur the penalty and lose the interest but in this low-interest environment, you won't be sacrificing much,

- money market, which is actually a money mutual fund of a variety of very short term investments ( may be FDIC insured if at a bank) and usually pays a higher return than a savings account,

- short-term bond fund, which is a grouping of bonds that mature soon and frequently. These are definitely not FDIC insured and will go up and down as the bond market reacts to various events. Because these funds hold very short-term investments, they are not very volatile, reasonably safe and offer a higher return.

Be $ Smart - find a good home where you earn some interest on your "safe" cash investments.

Personal stories...

We never know how our lives may be impacted.  Right now I am awaiting the arrival of Sandy and wondering what havoc the storm will wreak.   I also feel powerless with my daughter, 8 1/2 months pregnant, over 200 miles away wondering how she will fare with the storm's low pressure and a full moon!
Life sometimes throws us lemons; it's up to us to make lemonade.

Please read the personal stories of a few people whose lives I have been privileged to guide:
One wintry, snow filled night Louise R. and her husband, Stan were returning from a friend's home in the next town.  The roads were icy and Stan could not control the car.  Stan did not survive the accident and Louise was hospitalized for two months.  No sooner was she home than the insurance agent arrived with the check for the life insurance policy on her late husband.  Before he left, he had sold Louise an annuity using the insurance  proceeds.  Fortunately, Louise had a good friend who called me for assistance.  I was able to review the annuity, determine it was not appropriate for Louise and had her money returned to her.  Louise understood she was grieving the loss of her husband and was not able to make important decisions at this time.  She hired me to assist her with all financial decisions for one year.

Margaret L. came to me devastated on learning that her doctor husband of 28 years had been diagnosed with terminal cancer and had less than a year to live.  Margaret was an artist and never bothered with money leaving all the decisions and bill-paying to Hal.  Over the next six months Margaret met with me for one hour a week learning financial terms and taking  money-tasks home to perform.   She arrived for her appointment one day very excited about a visit to their estate attorney the previous day; she actually understood what the attorney had presented!

Cathy C.  had  a trust fund left to her by her grandparents.  She gave me a call to learn if she should refinance her mortgage.  After reviewing Cathy's substantial portfolio we were able to determine she had more than enough assets to pay off the loan  and live mortgage-free.   We also reviewed the charities to which she contributed 10% annually based on her family tradition.   We found new organizations that spoke to those things about which Cathy felt strongly.

Larry T. had suffered an injury while working as a carpenter apprentice for which he received a  reasonable  settlement.  We reviewed Larry's job prospects and financial goals.   Larry opened a savings account and paid off his credit cards and medical bills.  Once those items were satisfied Larry had enough money to put a downpayment on a small wood-working shop of his own.

Sally P. had been a nurse for almost 30 years.  She was single and frugal.  Toying with the idea of retiring in a few years, Sally wanted to start enjoying the fruits of her labors while she was still physically able.  Her dream was to take one BIG trip a year until she retired.  On reviewing Sally's savings, pension and social security we determined Sally would certainly have sufficient money to satisfy her wanderlust without jeopardizing her future.