Tax Talk

10/23/2002 12:00 am EST


I would emphasize to all readers that taxes are a complicated issue and no advice in an article or publication should be relied on in making one’s personal tax decisions.  Always consult with a tax advisor or other professional.  With that in mind, we offer some tax-related ideas that may impact investors.

“Every year about this time we do an article cautioning you to be very careful when investing in the fourth quarter because you could be liable for a year-end capital gains distribution you didn’t benefit from,” notes Sheldon Jacobs (The No-Load Investor). “This year, forget about it. There is no tax-related reason to wait until January if you want to buy mutual funds.  First of all, 78% of no-load equity funds have realized and unrealized capital losses according to the latest Morningstar data. These funds will not be paying any capital gains distributions at year end. The year ends of October 31 for purposes of computing the mandatory capital gains distribution. Secondly, even the funds that do make distributions will probably pay less. The fat distributions from the bull market years are gone.”

“No one likes to realize losses, but it is prudent to review your current tax situation in order to save tax dollars,” says Janet Brown (NoLoad Fund*X). “Consider taking fund losses now, and upgrading into a similar fund in the same class. If you sell a fund to realize the loss, you need to stay out of it for 31 days. Gains on fund sales held one year or less are taxed at your income rate (maximum federal tax rate is 39.1%), whole gains on sales held more than one year are taxed at the capital gains rate (maximum federal rate is 20%). If you have a net short-term loss, as most investors do this year, you can apply the balance against a net long-term gain. If you end up with a net loss, either short- or long-term, you can reduce your taxable income by the lesser of $3,000 (joint or individual returns) or the net loss. The remainder is rolled over to future years.”

“We announced several changes for investors in taxable accounts,” says Jim Lowell (Fidelity Investor). “The reason: tax-loss selling. For taxable accounts, we sold funds with current losses but which we want to own long-term, such as Fidelity Dividend Growth and Fidelity Structured Large Cap. We replaced it immediately with a similar fund, Fidelity Blue Chip Growth - and we must wait 31 days before buying back the original fund. This way we took the taxable losses and can recoup a third of our losses through tax savings of up to $3,000 against regular income each year, and in unlimited amounts against future year's capital gains, while all the while remaining invested in the same area of the market. The strategy works best when the market rallies in the interim since we get to bank the losses and the gains. Other similar switches include selling Fidelity Low-Priced Stock and placing the proceeds into Fidelity Cash Reserves with an eye towards repurchasing Low-Priced in 31 days. We are also selling Small Cap Independence and purchasing Fidelity Over-the-Counter with the proceeds. And we are selling Fidelity High Income and purchasing Select Health Care.”

Caren Chesler, in Financial Advisor magazine, suggests looking at tax credit funds as a strategy to lower one's tax liability. “Founded in 1974, Boston Capital has made a business of turning the federal government's annual allocation of tax credits for affordable housing into an investment product individuals can use to lower their tax bills. Boston Capital is a major force in the tax-credit market, selling its funds to both corporations and retail investors. The IRS limits the number of tax credits an investor can use each year before the alternative minimum tax (AMT) kicks in. For people in the highest tax bracket, for instance, the maximum number of tax credits they can use each year is about $8,700. The retail product has been popular particularly among retirees because the annual tax credits enable them to take about $25,000 tax-free each year from their IRAs for as long as the fund exists. Most last about 12 years. Investors prefer tax credits to tax deductions because they receive a $1 benefit for every $1 invested. Tax deductions, on the other hand, simply reduce one's taxable income, so investors only receive a benefit equal to the amount they would have been taxed on that dollar.”

For those attending The New York Money Show, I would note that both Janet Brown and Jim Lowell will be presenting in-depth seminars for those interested in learning more about their mutual fund strategies. Boston Capital president Richard DeAgazio will offer workshops for those interested in tax credit funds.

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