NEW YORK (TheStreet) -- As 2014 comes to a close, proper tax planning will help savvy investors reduce what they pay on investment gains, as well as take advantage of tactics that might not be available in the future.
Here are three tips investors should consider when filing their 2014 tax returns.
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1. Tax Loss Harvesting and Selling in Lower Tax Brackets
The idea of selling securities (such as stocks or mutual funds) that have gained significant value may seem foolish. But for individuals wanting to take advantage of current tax loopholes, selling may not be such a bad idea. Tax loss harvesting is essentially offsetting the gains on a well-performing stock or mutual fund account by selling an underperforming asset.
An investor in the 25% federal tax bracket invests $25,000 each in 4 different stocks, for a total of $100,000. The stocks are held for a year or more. The current status of each stock is as follows:
- Her stake in stock A has increased $2,000;
- Her stake in stock B has decreased $6,000;
- Her stake in stock C has increased $3,000;
- Her stake in stock D has decreased $9,000.
The total investment at this point is down $10,000, yet the investor could be required to pay taxes on the investments that gained value.
By selling now, the investor can offset the long-term capital gains in stocks A and C (which increased a total of $5,000) with the losses from stocks B and D (which decreased a total of $15,000). That's a total capital loss of $10,000. She can use up to $3,000 of this loss to offset her ordinary income for the current year, resulting in a tax savings of $750 ($3,000 in capital loss x 25% tax bracket = $750).
On top of that, she can carry the remaining $7,000 loss onto her future tax returns, offsetting future gains or repeating the same $3,000 offset to her ordinary income for the next couple of years.
For those in a tax bracket above 15%, selling securities with significant losses to offset taxes on gains of appreciated assets can save up to 23.8% in taxes on long-term capital gains. Why? There's now a 3.8% surtax on individuals earning more than $200,000 and married couples earning more than $250,000. And capital gains taxes are at 20% for those who earn taxable income over $406,751 filing as a single person and $457,601 for married couples. So offsetting those gains with losses is a good idea.
Those in the 15% tax bracket or lower -- with $36,900 or less in taxable income if you're filing single; $73,800 for married couples -- will pay 0% on long-term capital gains (capped to a certain dollar amount).
Note: IRS wash-sale rules disallow you to claim a loss if you purchase a similar investment within 30 days.