Who: Lynne Spichiger, 65
Where: Belchertown, Mass.
Question: Can I sell some winners to take advantage of the temporary 0% tax on capital gains for investors like me, then buy them right back?
Lynne believes she has a clever tax trick up her sleeve. She wants to sell some winning stocks sometime during 2012 to cash in on the expiring 0% tax rate for some taxpayers on long-term capital gains. But she wants to go on investing in her favorites, so she intends to buy back those shares. "This way, when I sell those stocks in the future, I'll have restarted at a higher cost basis and won’t be hit as hard with taxes," says Lynne.
Zero taxes and stock market profits are rarely in the same conversation, but Lynne, a self-employed grant writer and instructional designer who files taxes as single, is eligible for this benefit for two reasons. First, she expects her 2012 income to be small enough to qualify for the 0% capital gains provision, which phases out for single filers at a taxable income of $35,350 (the limit is $70,700 for joint returns). Second, she's held her winners, which include McDonald’s (symbol MCD) and Caterpillar (CAT), for more than one year. But before she acts, Lynne wants to be sure the strategy will work.
Good news for Lynne. She's on the right track. "That's a brilliant tax maneuver," says Sheryl Garrett, founder of the Garrett Planning Network. As long as Lynne avoids a few traps, she's off to the races.
The first pitfall would be allowing the gains to push her over the income limit. As it happens, Lynne says she wouldn’t mind overshooting the 0% income limit—and owing 15% tax on the slice of the profits that exceeds it—because she wants the money before she begins collecting Social Security in 2013. From that point on, if her taxable income tops $25,000, the government will tax up to half of her Social Security payments; if she earns more than $34,000, then up to 85% is taxable. Anyone on the verge of claiming Social Security should investigate whether it pays to grab capital gains early.
Trap number two would result from sloppy math or poor record keeping. Capital gains are calculated by subtracting what you paid for an asset (plus fees and commissions) from the sale price. But what happens if you’ve reinvested dividends, which is common with blue-chip stocks and almost automatic with mutual funds? That ratchets up your cost basis and reduces the capital gains or conceivably triggers a loss. Review your statements or check with your brokerage firm to make sure you report the proper gains.
Lynne's third hurdle is the risk that the stocks she plans to buy back will skyrocket before she can get back in, thus reducing her returns. Lynne says that she'd like to wait for a pullback before repurchasing her stocks. But with McDonald’s and Caterpillar more than holding their value, she may have a long wait. Fortunately, blue-chip stocks like hers are liquid; Lynne can buy back her shares whenever she wants.
It is generally unwise to let tax strategy dictate investment moves. But Lynne is an exception because she has access to an unusual tax break. "Lynne is working the tax system legally and effectively," Garrett says. You can't ask for more.