Course 206: The Best Investments for Taxable Accounts
Other Ideas for Tax Relief
In this course
1 Introduction
2 Very Low Turnover Stock Funds
3 Tax-Managed Mutual Funds
4 Municipal Bonds or Municipal-Bond Funds
5 Individual Stocks
6 Exchange-Traded Funds
7 Variable Annuities
8 Other Ideas for Tax Relief

Here are some other strategies you can practice to limit how much of your taxable account Uncle Sam gets to take.

Buy and hold.
The best way to avoid capital-gains taxes is simply to refuse to sell an investment. Of course, you (or your heirs) will eventually need to sell shares to cash in on an investment's appreciated value. Still, it makes more tax sense--and more investing sense in general--to buy and hold for the long run. If you really want to trade on a regular basis, do it in an individual retirement account or a 401(k) plan, since those transactions are shielded from taxes.

Pay attention to holding periods.
When you sell any investment, you have to pay capital-gains tax on your profits. Under current law, you owe taxes on short-term gains--those from investments that you've held for a year or less--at your ordinary income-tax rate. By contrast, if you've owned the investment for more than a year, you'll owe much less. In 2012, that long-term rate is 15% if you're in the 25% tax bracket or higher, and 5% if you're in the 10% or 15% tax bracket.

Thus, if you have a choice between selling a winning investment that you've held for six months and one that you've held for two years, unloading the latter will result in a lower tax hit. Or, if you're considering selling an investment that you bought 11 months ago, waiting a few extra weeks could be worth your while from a tax standpoint.

Offset capital gains with losses.
If you sell an investment for less than you paid for it, the difference counts as a capital loss. The silver lining to such losses is that they cancel out capital gains, lowering your taxes overall. If your capital losses exceed your capital gains in a given year, you don't have to pay any capital-gains tax, and you can deduct a net loss of up to $3,000 from your taxable income (and carry over any unused losses into the next year).

That's why it's sometimes a good idea to think about selling some of the losers in your portfolio near the end of the year. If you still like these investments for the long term, you can buy them back after waiting 30 days. This rule prevents "wash sales," in which somebody sells a stock to claim a capital loss but then repurchases it immediately to retain ownership.

Pay attention to cost basis when selling shares.
When you sell an investment, the taxable capital gain depends on your cost basis, or the price you paid for the stock. If you bought shares of the stock at different prices, you can sometimes reduce your capital gains, and thus the tax you pay, by specifying that you're selling shares bought at the higher price.

For example, suppose you buy 100 shares of a stock at $10 a share. The stock rises to $20, and you buy another 100 shares. Eventually the stock reaches $30, and you decide to sell 100 of your shares.

Without specific instructions, most brokers and fund families would sell the first shares you bought, and your capital gain would be $2,000, or the $3,000 sale price minus your $1,000 cost basis. But if you specify that you want to sell the shares you bought for $20, your capital gain will only be $1,000, or $3,000 minus a $2,000 cost basis.

There's one catch: You usually need to specify in writing which shares you're selling. That can be difficult, especially with discount brokers. Still, it's worth the effort if you've bought shares at very different prices and need to sell some of them.

Next: The Quiz >>


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