How to Decide if You Should Sell Stock to Cut Taxes
Be careful about rummaging among depressed stocks for bargains at this time of year. Tax-related selling could make some cheap stocks a lot cheaper before 1992 is over.
Many investors take time in late November and early December to tally up their stock winners and losers for the year. Because the federal tax code allows investors to offset capital gains with capital losses, people who’ve scored big in the market often decide to dump any losers they have, to shelter their gains from Uncle Sam.
Thus, it’s an irony that some of the most vulnerable stocks near year’s end are those that have already plummeted from their highs earlier in the year. Investors who’ve stayed with these losers--hoping for a turnaround--figure they may as well just jettison the stocks to generate a capital loss.
It used to be that tax-related selling occurred like clockwork in the last few weeks of December. But in recent years, many stock pros say investors have begun such selling as early as October--trying to get a jump on their peers, and to avoid selling at what they expect to be even lower prices later in the year.
“It’s been harder and harder to figure out the timing the last few years,” says Robert Reed, executive vice president at discount brokerage Jack White & Co. in San Diego. He surmises that’s because “people are a little more educated” about investing, and keep better track of their tax situation and portfolio status as the year progresses.
James Alexander, principal at J. Alexander Securities in Los Angeles, believes that tax-related selling has been a “non-event” so far this year. He attributes that partly to the broad rally in small NASDAQ-listed stocks, which has left many individual investors (who dominate trading of most NASDAQ issues) with a lot of winners, but relatively few losers.
Indeed, the powerful rise in the NASDAQ market in the last few weeks has given investors much incentive to buy, while also convincing many that it’s too early to sell their winners, says Bill Sulya, small-stock trading chief at St. Louis-based brokerage A. G. Edwards & Sons.
The NASDAQ composite index of 4,000 mostly small stocks reached an all-time of 649.49 Friday. The index has jumped 7.3% just since Oct. 31.
“The NASDAQ market is as strong as I’ve seen it in a year--maybe as strong as I’ve ever seen it,” Sulya says. “I just don’t see any weakness.”
What’s more, Alexander notes, some investors are reluctant to take profits in their winners this year because of rumors that President-elect Clinton will include some kind of capital-gains tax cut in his economic proposals for 1993.
Still, market pros caution that there’s a lot of time for profit taking to kick in before January. And if it does, the weakest stocks are likely to be sacrificed, to create offsetting capital losses.
“If you’re looking at the need to take a loss, you could get hit” further in the price by waiting, Sulya says.
The flip side is that bargain hunters eyeing beaten-down stocks also should wait, traders say: There’s a good chance you’ll get the market’s dogs cheaper before the year ends.
If you’re uncertain whether to do any juggling of your stocks this year--given the political uncertainty about 1993--you aren’t alone. Here are some tax experts’ tips for investors wrestling with buy and/or sell decisions:
* First, never let tax considerations override investment decisions. Evaluate stocks based on their individual prospects, not solely on the tax merits of buying or selling. “The more important decision lever is, what do you think is going to happen with the underlying stock price?” says Andrew Harwood, tax partner in the downtown Los Angeles office of accounting firm Price Waterhouse.
Some investors may be tempted to take capital gains now because they know that President-elect Clinton has suggested raising the top federal tax rate to 36% from 31% for upper-income taxpayers.
But Harwood notes that while the top tax rate on ordinary income could rise, it isn’t clear whether Clinton would raise the top capital gains tax rate from its current 28%. And as noted earlier, there have been hints that Clinton could even propose lowering the capital gains tax as an investment incentive.
“We’re telling clients to realize that nothing (from the Clinton camp) is set in stone,” says Brian Frazier, partner at accounting firm Arthur Andersen & Co. in Los Angeles. So if you’re happy with your portfolio, the best advice may be to leave it alone.
* Keep perspective: The tax changes suggested so far aren’t extreme. An important point for worried investors to consider, Harwood says, is that even if the top tax rate goes to 36%, it would be a relatively small rise from 31%.
It isn’t as if Clinton is proposing a 50% tax rate, or some other dramatically higher figure that would merit serious portfolio shifting.
The same advice applies to investors who may be waiting to take capital losses in 1993, figuring they’ll be worth more if tax rates go up. Remember: If you don’t have capital gains, the maximum amount of capital losses deductible from ordinary income remains just $3,000 annually--not a big shelter.
If your losses exceed that sum, and you don’t have capital gains to offset them, you must carry the losses into future tax years.
* If you want to sell a loser stock and buy it back later, remember to wait at least 31 days. This is an old rule, but people forget: If you take a loss on a stock (or mutual fund) and then repurchase the same security within 31 days, the Internal Revenue Service disallows the loss for tax purposes.
Why repurchase a dog? Some investors may want to realize a paper loss they’ve incurred so they can offset capital gains. But they may still believe that the dog stock has long-term promise--so they want to put it back in their portfolio. Just be sure to wait 31 days.
* Consider giving appreciated stock to charity rather than selling it for a capital gain. Once you reach a decision to sell a stock, giving it away may make more sense--if you were planning to give to charity anyway.
The reason: You can take a tax deduction for the full value of the stock. That beats selling the shares, incurring a capital gains tax, then making your charitable donation with the remaining cash.
By giving stock direct, you keep Uncle Sam out of the transaction. But if you’re giving a substantial amount away, be careful about triggering the so-called Alternative Minimum Tax on your income. If in doubt, consult a tax expert.
Still Vulnerable to Tax Selling? These stocks, already down sharply this year from their highs, could fall further in December if more investors decide to sell in order to realize capital losses for tax purposes.
1992 Friday Pct. drop Stock (Market*) high/low close from high Glenfed (N) 8 1/2-1 1 3/8 -84% Quarterdeck Systems (O) 26 5/8-4 5 1/2 -79% Aura Systems (O) 12 1/4-2 1/2 3 3/4 -69% Datron Systems (O) 14 1/4-4 1/2 5 -65% Tokos Medical (O) 44 3/4-15 16 -64% Failure Group (O) 17 3/4-6 1/2 6 1/2 -63% National Education (N) 12 1/4-4 5/8 5 1/2 -55% City National (N) 16-4 5/8 7 3/8 -54% Digital Equipment (N) 65 1/2-31 1/2 32 1/4 -51% Benton Oil & Gas (A) 11 1/8-5 5 1/2 -51% American Health Properties (N) 37-19 1/4 20 1/4 -45% Biowhittaker (N) 14-7 7/8 8 1/8 -42% Homestake Mining (N) 16 5/8-10 10 3/8 -38%
*Markets: N-NYSE; A-Amex; O-NASDAQ
