Investor Options for Tax-Related Year-End Moves

Year-end tax planning for investors has rarely been this complicated.

Or is it?

Normally, year-end advice is to offset realized capital gains with losses, defer additional gains till the following year and accelerate deductions into the current year.

Many investors also have been conditioned to bargain hunt for small stocks that may get socked by tax-related selling in November and December.


This year, however, the stock market has been so strong that many investors are having trouble finding capital losses to match against gains, accountants say.

What’s more, while Congress has voted to cut the capital gains tax rate, the effective date of the cut--now Jan. 1, 1995--could be changed in upcoming negotiations with the White House. Or President Clinton could refuse to sign any capital gains tax cut, period.

What to do? Here’s a primer for investors who are mulling their options:

* Should you realize long-term capital gains before Jan. 1?

Many financial advisers say that, all other things being equal, it’s still a good idea to wait until January to sell investments that will produce a long-term gain (i.e., you’ve held the assets for more than one year).

Why wait? As mentioned above, the tax legislation that the Republican-dominated Congress will soon send to President Clinton would cut the maximum long-term capital gains tax rate, now 28%, to 19.8%. The lower rate would be effective for all long-term assets sold since Jan. 1 of this year.


But Robert Willens, a tax specialist at brokerage Lehman Bros. in New York, warns that the lower tax rate could end up applying only to assets sold after Jan. 1, 1996. Clinton could demand such a compromise (which would save the Treasury otherwise lost tax revenue) before agreeing to a final budget plan that would basically give Republicans most of what they’re looking for.

The risk in waiting to sell, of course, is that the value of the assets will decline between now and Jan. 1. Yet there are ways to lock in a capital gain, Willens notes: You can use a strategy known as “selling short against the box,” using borrowed securities to hedge against a decline in your own, or you can use “put” options on individual stocks or on market indexes to do the same.

* Should you realize capital losses before Jan. 1?

If you have already realized capital gains this year--and don’t forget to count automatic capital gains payments from your stock mutual funds--using losses to offset those gains makes sense, as usual. After all, each $1 in losses offsets $1 in otherwise taxable gains.

The problem may be finding significant losses among your investments. Given robust stock and bond markets this year, “the reality is that there are very few losses in many portfolios,” says Ken Anderson, tax partner at accounting firm Arthur Andersen in Los Angeles.

Financial advisers warn that you should approach all decisions about selling securities based first on economic considerations. In other words, don’t sell just for tax reasons--sell if you truly don’t think the investment is worth holding, or there are better alternatives for that capital.

If you do indeed have large long-term losses you want to realize, they may be more valuable in 1995 than in 1996, Lehman’s Willens says: Losses in excess of any capital gains can be used dollar-for-dollar to offset ordinary income, such as wages, up to $3,000 this year. But starting in 1996, the new tax bill makes long-term losses only 50% deductible against ordinary income, also up to a $3,000 annual limit.

* Will year-end bargain hunters be disappointed?

In down years on Wall Street cheap stocks often get cheaper in November and December as investors sell to realize losses for tax reasons. That often gives bargain hunters a field day, particularly with smaller, more volatile stocks.

This year, thanks to the market’s gains overall, “I think that [year-end selling] effect is going to be very muted,” says Carlene Ziegler, co-manager of the Artisan Small-Cap stock fund in Milwaukee.

What’s more, Ziegler notes that the shares that have suffered beatings--in such sectors as autos, retailing and Third World stocks--may not be such great bargains even if they go lower. “If you have a loss in a stock this year, it’s probably because something really went wrong,” she says.

That doesn’t necessarily mean investors won’t find more bargains as the year draws to a close, but you’ll have to look harder. One possible twist: If Congress and Clinton agree on a capital gains tax cut sometime in December, that could spark a surprising amount of selling as some trigger-finger investors immediately react. If the market takes a hit for that reason, bargain hunters may enjoy much better pickings.