Now is a good time to clean up your investment accounts. If you have taken capital gains this year, consider offsetting them by taking losses. Taking a loss is a lot easier to swallow if you know that it will benefit your pocketbook. If you do not have capital gains this year, or have more losses than gains, you can write-off up to $3,000 of losses against income. If you have “realized” more losses than you can use, you can carry forward unused losses to subsequent years. You may have stocks that are worthless, as was common after the dot-com bubble burst. While there may not be an active market for such a stock, you can work with your broker or advisor to find the best way to treat the loss for tax purposes.
As an example, say you purchased 200 shares of Bank of America stock at $43 each on August 31, 2005, which you sold one year later at $52 a share, for a profit of $9 a share or $1,800. Believing the housing market would continue to be strong, you also bought 100 shares of Toll Brothers stock at $48 a share. One year later when the housing market cooled, the stock dropped to $26. You now have an “unrealized” loss of $22 a share or $2,200. To help offset the gain on the Bank of America stock sale, you could sell your Toll Brothers for a net loss of $400. This amount could be used to offset income this year. If you believe that home building stocks as a group will recover, you could immediately replace it with a similar stock in the same industry. The IRS doesn’t allow you to repurchase the identical stock until 31 days after the sale or it would be considered a “wash sale” and the loss would not be deductible. It pays to hold stocks for the long term as short-term gains (investments held for one year or less) are taxable at your current tax rate and long term gains (investments held for over one year) are taxable at a five to 15 percent rate depending on your income. Also, short-term losses can be used to offset long-term gains and vice versa.
Gifting stock is another way to reduce tax liabilities. Making a charitable contribution before year-end by donating appreciated stock can both fulfill your philanthropic desire and allow you to take a deduction for the amount the stock is worth. This avoids paying a tax on the gain and you get a tax break with the deduction. To qualify for the full deduction of the gift, you do need to have held the asset for at least one year. You could also contribute stock to a donor advised fund and receive an immediate tax deduction. This would allow you to gift the funds over time to as many charities as you wish.
If you are planning on selling an appreciated stock and also planning on giving money to a minor, you may consider gifting the appreciated stock to them instead. Under the Uniform Transfer to Minors Act (UTMA), one can contribute to a minor’s account while an adult acting as custodian maintains control over the assets. Although the account is legally the minor’s, the adult decides how the funds are invested until the child reaches legal adulthood. While there is no tax deduction, it allows you to avoid paying the capital gains tax (which would be paid by the minor when the shares are sold).
It is also prudent to review your mutual funds. Mutual funds are required to pay out dividends and capital gains at least once a year. Most funds do this in November and December. If you have a fund that is an underperformer, it may be wise to sell it before the distribution date. Although distributions do not increase the value of your holdings, you still have to pay taxes on them regardless of whether the fund has risen or fallen in value. This is one of the disadvantages of owning mutual funds versus holding individual stocks in a taxable account. On the date of the distribution, the mutual fund will drop in price to reflect the amount of capital gains and/or dividends. If the dividend is reinvested, you will buy more shares, but the value of your fund holdings will not change. You can call your mutual fund company before the distribution date and they should be able to provide you with an estimate of how much the distribution will be.
These are just a few basic strategies that can help you come out ahead at tax time next year. Keep them in mind as things to do before the end of the year and enjoy your holidays.

John Reimer, CFA is a portfolio manager with Stellar Capital Management in Phoenix.
www.stellarmgt.com