It's December, and That Means . . .

By TOM PETRUNO

Dec. 2, 1997 12 AM PT

The calendar says you have two things to worry about this month: enjoying the holidays, and checking whether you need to make any year-end tax-related adjustments to your investment portfolio.

For many investors, the best decision may be to do nothing. If you’re happy with your portfolio and your long-term strategy, don’t bother tinkering solely for tax reasons.

But it’s a good idea to at least ask yourself some questions about your financial status at this time of year, while there is still time to make potentially tax-saving changes before the Dec. 31 deadline.

Where to focus:

* Could you use some losses to offset gains? If you have loss-ridden investments that you’ve been thinking about jettisoning anyway, you may have more incentive to sell this month if you also have realized hefty capital gains this year.

Realized gains, of course, occur when you sell a security at a profit. But even if you haven’t sold anything, remember that you may still have large taxable gains if you own mutual funds--which must distribute most of their annual realized gains to shareholders by Dec. 31.

Those distributions aren’t a tax concern if they’re in a tax-sheltered account such as a 401(k) plan, but any funds you own outside tax-sheltered accounts will probably produce taxable capital gains for you in 1997, given the U.S. stock market’s continued rise.

Realized losses offset realized gains dollar for dollar on your tax return. But the accounting has gotten more complicated thanks to the new tax law, which created three tax brackets for securities gains.

For assets sold before being held 12 months, the tax on any gain is the same as your ordinary income tax rate, up to 39.6%; for assets sold after being held between 12 and 18 months the top gains tax is 28%; and for assets sold after being held for more than 18 months the top tax rate is 20%. (Note: The 20% rate also applies to assets held at least 12 months and sold between May 7 and July 28, as per the tax law. Assets sold before May 7 are taxed according to the old law.)

On your tax return, realized losses first will offset gains of the same term; then, if you have excess losses in a category, they can be allocated to offset other gains.

Many tax pros advise that you avoid generating gains that might “waste” realized losses: You can use up to $3,000 in short-term losses to offset ordinary income each year. If you’re in a high tax bracket, that may provide more tax savings than using those losses to offset long-term capital gains that would be taxed at just 20%.

* If you want to sell a security for a loss, then buy it back, be aware of the “wash-sale” rule. Some investors who choose to part with their losers to generate tax losses may still believe that the securities have great long-term promise.

You can buy back a loser after selling for tax reasons--but the IRS requires that you wait 30 days between the time of the sale and the date of the buy-back, or the loss you took will be disallowed for tax purposes.

If you don’t want to wait because you think a particular industry group is ripe for a rebound soon, you could simply buy a different stock in the industry as you sell your loser. As long as the securities are “substantially different” (the IRS’ term) you don’t have to worry about violating the wash-sale rule.

Note to bargain hunters: Tax-related selling often makes depressed stocks even more so in the first two weeks of December. But by the last two weeks of the month, value-seeking investors may take over. (Of course, it’s also worth noting that depressed stocks often get that way for good reason; just because it’s down doesn’t mean it has to come back soon--or at all.)

* Do you want to lock in unrealized capital gains now, while deferring the sale (and thus taxes) until next year? Any “taxable event” you can push into 1998 will delay taxes owed until April 1999.

Robert Willens, tax expert at Lehman Bros. in New York, says that “most of the questions I get now are about hedging or deferring capital gains.”

One favored strategy: “selling short” against the box, whereby you protect an unrealized capital gain you already have while deferring the sale of the security till next year. You do this by selling short the security you wish to protect.

Selling short involves borrowing stock (from a brokerage) and selling it in the open market, with the intent of repaying the borrowed shares later.

Under the new tax law, Willens says, when selling short against the box you must close out the short position by Jan. 30. And you must do so by buying new stock in the open market; you can’t use the shares you already own.

But the end result is the same: You have locked in whatever gain you’ve got thus far on the security.

(As easy as this may look, it’s still a good idea to consult a tax advisor before you jump into such transactions.)

There are other ways to protect gains into the new year as well. Another popular strategy, Willens says, is the use of “collars”--simultaneously buying “put” options on a security and selling “call” options, where the “strike” prices and maturities of the puts and calls are similar.

A put is a right to sell a certain number of shares at a predetermined price, by a set date; a call is the right to buy a certain number of shares at a predetermined price, by a set date. With a collar constructed with both puts and calls, the net effect is to limit the impact of any price swings in the actual security for the term of the collar.

But be careful: The IRS can judge that you in effect realized the gain on the security if you construct the collar too tightly relative to the security’s market price and the strike price of the puts and calls. Willens recommends that the puts and calls be at least 6% to 8% “out of the money” (meaning their distance from the security’s market price) to keep the IRS happy.

Should you hedge? Naturally, that depends on how worried you are about what the price of a security, or the market overall, will do in the near term.

Hedging isn’t free. There are trading costs, plus the market prices of any puts or calls you buy.

Robert Wagman, partner in charge of the personal finance group at Price Waterhouse in Los Angeles, says of collars and other hedging techniques: “I think fewer people use them than talk about them.”

For example, Wagman finds that many of his individual clients who hold significant stock options in their employers “are showing a greater inclination to exercise and hold” those options for at least 18 months, to qualify for the long-term capital gains break, rather than exercise and sell immediately, or make hedging moves.

Willens, too, believes that many individual investors still have to be pushed to sell a stock. The lower capital gains rate of 20%, he said, “hasn’t in my experience dampened enthusiasm” for just holding on, as opposed to cashing out of some gains.

Wagman thinks there are more important questions that investors ought to be asking at this time of year than simply how to save on taxes. He suggests focusing mainly on whether your overall investment portfolio is properly diversified.

That is particularly important for people who own a significant number of shares, or hold a lot of stock options, in their employer, Wagman points out. “I think most people have a desperate need to diversify,” he said.

Once that issue is addressed, “then you can get into the math” of making year-end tax-related adjustments, he said.

Tom Petruno can be reached at tom.petruno@latimes.com

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Tax-Loss Sale Candidates

The U.S. stock market overall is still up sharply this year, even after October’s slump. But some stock sectors have been hammered--which may make them vulnerable to year-end tax-loss selling, as investors clean out losers to generate losses that can offset capital gains. Here are some industry groups, and some individual stocks, that are down sharply year-to-date:

Sector: Gold

Year-to-date decline: -38.1%

Stocks and declines from 52-week highs: Echo Bay, --73%; Barrick Gold, --47%; Newmont Gold, --37%

Sector: Engineering

Year-to-date decline: --35.9

Stocks and declines from 52-week highs: Fluor, --51%; Morrison Knudsen, --33%

Sector: Misc. metals

Year-to-date decline --24.

Stocks and declines from 52-week highs: Inco, --46%; Asarco, --28%; Phelps Dodge, --27%

Sector: Photography

Year-to-date decline: --22.3

Stocks and declines from 52-week highs: Eastman Kodak, --35%; Polaroid, --29%