New Tax Law: Great Capital Gains, Little Pain

"In the middle of difficulty lies opportunity." – Albert Einstein

Albert Einstein was a smart guy – and not just because he was wise in the ways of science.  He was wise in the ways of life, too – especially when it came to finding opportunity at times of great storms and strife.

It’s a good lesson for investors to embrace. Consider the capital gains tax extension, which is a piece of the new tax law passed by Congress and signed into law by President Obama back in December 2010.

Congress and the White House have agreed to keep capital gains tax rates right where they are – for two years, at least. Investors catch a break, as the top rate on long-term capital gains stays at 15% for the next 2 years. Another stay of execution for investors –  the top rate for qualified dividends (meaning certain stocks held longer than 60 days) remains at 15% in 2011-2012.

How to Take Advantage

Nobody owns a crystal ball, and nobody can predict the future. The massive amount of government debt accumulating in Washington is expected to reach $1.5 trillion in 2011, as estimated by the U. S. Congressional Budget Office (CBO). It’s a good bet that, come 2013, most tax categories will be higher … maybe a lot higher, if many members of Congress get their way.

Until then, U.S. investors have a 2-year “window of opportunity” to take full advantage of relatively low capital gains tax rates. What strategies work best? Let’s take a look:

• Re-embrace “buy and hold.” The traditional buy and hold strategy has been kicked to the curb in recent years, as investors balked at holding on to losing stocks as their investment portfolios were in free fall. But as the market picture brightens, buy and hold has some advantage thanks to the 15% capital gains tax rate. If you hold your stock for at least a year, the maximum you will pay is a 15% capital gains tax rate once you sell.

• Go on a “dividend” hunt. The 15% capital gains tax rate gives you some good incentive to search out stocks or other appreciable assets that pay regular dividends. Dividends are like found money for investors – when reinvested, they give you an even stronger ownership position in the company.

• Hold on to your assets for more than one year. As noted above, to really leverage the lower 15% capital gain rate, the Internal Revenue Service declares that a capital asset must be held at least one year or longer. Thus, it is critical when selling your appreciated stocks, bonds, investment real estate and other capital assets, to keep a sharp eye on the asset’s holding period. If it is one year or less, your may want to defer the sale in order to meet the one-year-or-longer threshold and take full benefit from the long-term capital gains rate through 2012. One caveat: Any realized capital gains that you take may hike your adjusted gross income (AGI), which can decrease your alternative minimum tax (AMT) exemption, and thus potentially increase your AMT exposure.

• Lower tax bracket? Consider selling by 2012. One little-known provision in the new tax law is that lower-income taxpayers get a real break on the capital gains tax - 0% capital gains for 2011-2012 (see chart below). That may not be the case in 2013, so consider selling your winners by New Year’s Eve 2012. It should be a capital gains tax-free transaction.

• Take Full Advantage of the 2-Year Extension

  With capital gains tax rates remaining stable for the next 2 years, investors can exhale – and make good use of that 2-year window. But don’t wait too long. By January 1, 2013, the tax terrain may well shift to higher ground. That’s why taking full advantage of current tax opportunities isn’t a luxury – it’s a necessity.

   

  You don’t have to be Albert Einstein to figure that out.

CHART: 2011-2012 capital gains tax rate depends on your tax bracket

Source: IRS.gov 

This information in this article is general in nature and may not apply to your own financial situation. Please consult your own professional tax advisor regarding this information and your own personal tax needs. For a complete disclosure statement, click here.