Year-end planning for mutual funds

If you’ve sold mutual fund shares at a gain during the year, there are some year-end moves you can make to soften the tax blow. One strategy is to “harvest” capital losses (by selling investments that have declined in value) and using those losses to offset the gain. You can even buy back the investments after deducting the loss, so long as you wait at least 31 days.

Another strategy is to ensure that mutual fund shares with the highest cost basis are sold first, minimizing your gains. To do this, use the “specific identification” method for calculating basis and inform your broker which shares you wish to sell. Absent such instructions, the first-in, first-out method will be applied by default, which may increase your capital gains.

Beware deduction limits

A basic precept of year-end tax planning is to defer income to next year and accelerate deductions into the current year. But as you consider your options, keep in mind that deduction limitations for high-income taxpayers may reduce the effectiveness of this strategy.

The limits apply to deductions for taxes paid, interest paid, charitable gifts, job expenses and certain miscellaneous deductions. They don’t apply to medical expenses, investment interest expense, or casualty, theft and gambling losses.

Tax-free capital gains?

For taxpayers in the middle and upper ordinary-income tax brackets, long-term capital gains are taxed at rates ranging from 15% to 23.8% (including the 3.8% tax on net investment income). Taxpayers in the 10% and 15% ordinary-income brackets, however, enjoy a 0% tax rate on long-term capital gains. One way to take advantage of tax-free capital gains is to transfer stock or other investments to family members in the two lowest tax brackets — for instance, single filers with taxable income of $37,950 or less in 2017 ($75,900 for married couples filing jointly).

A few caveats:

  • Consider potential gift tax consequences before transferring assets.
  • Watch out for the “kiddie tax.” Generally, if you transfer capital assets to a dependent child under the age of 19 (24 for a full-time student), any unearned income (including capital gains) in excess of $2,100 will be taxed at the parents’
  • The 0% rate applies only to the extent that capital gains increase the recipient’s taxable income to the top of the 15% bracket. Additional long-term capital gains are taxed at 15% until the highest bracket is reached; then they’re taxed at 20%.

© 2017

This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.