Posted By: John Steele

Donald Jay KornFri Nov 10, 7:00 PM ET

Year-end tax planning means it is time to address one of an investor's key goals: eliminating taxable gains. The basic tactic is to offset them with capital losses.
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Since long- and short-term gains are taxed at different rates, so-called ordering rules require taxpayers to apply gains and losses of the same type against each other first. If you have net gains left over after that, you can offset them with any remaining losses of a different holding period.

Begin by tallying results of your trades this year. In dollars, how much do you have in long- and short-term winners and losers? Securities, including mutual funds, you have held more than 12 months are long-term.

Next, net long-term gains against long-term losses. Then net your short-term gains and losses.

Include any capital gains distributions from mutual funds held in taxable accounts. Your fund company's Web site probably has estimates of year-end distributions. If you can't get an estimate online, call your broker. Or call the fund company.

Also include any other capital gains or losses realized this year. You may have sold investment real estate, for example.

Then, your likely tax obligation from these transactions will fall into one of three basic scenarios.

First, if you have both net long-term gains and net short-term gains, you will owe tax in both categories. Most net long-term gains are taxed at 15% for taxpayers in the 25% federal income tax bracket and higher.

Net short-term gains are taxed as ordinary income. For 2006, those rates go up to 35%. You may owe state tax too.

Second, if you have long- and short-net losses, you are assured of having a net loss so far this year.

The third possible scenario is to have a mix of gains and losses.

For instance, if you have a gain -- either long or short term -- and a loss of the other type, you should net them against each other.

Any leftover, net short- or long-term losses simply count as net capital losses. You don't get a credit or deduction at a specific rate.

Carry-Forwards

"For tax purposes, one strategy is to wind up with at least $3,000 in net capital losses," said Tom Ochsenschlager, vice president, taxation, for the American Institute of Certified Public Accountants. That's the most you can deduct against your other income in one year.

Net losses over $3,000 can be carried into future years.

Once carried forward, you can start the whole process again. You can use carry-forwards to offset any net gains. Any outstanding net losses, up to $3,000 a year, can be deducted from your taxable income.

Say you go through all the calculations and estimate you'll have $15,000 in net long-term gains and $4,000 in net short-term gains for 2006, if you take no further action.

Now look for any type of losses. Your aim is to have $22,000 by year end. Those losses can offset your $4,000 in short-term gains plus $15,000 in long-term gains. It'll also leave an excess of $3,000. You can use that net loss as a deduction.

Then you'd owe no capital gains tax. Instead, you'd cut your overall taxable income. That cuts your tax bill.

To preserve your tax losses, you must proceed with caution. If you buy back the same security within 30 days, your tax loss won't count.

That's the wash-sale rule. Three techniques can avoid wash sales, yet preserve your portfolio makeup..

Wait. You can park your money in an interest-bearing account. After 31 days, you can repurchase the security you sold at a loss. Your portfolio will be intact, but you risk missing a run-up in that security while you're on the sidelines.

Buy something similar. If you sell a retailer's stock at a loss, for example, you can buy the stock of a competing retailer right away. You will maintain exposure to the sector but you'll be backing the second company rather than your first choice.

Double up. Say you own 500 shares of Retailer ABC, now trading at a loss. At least 31 days before you plan to sell the shares, buy another 500 shares.

After 31 days, you can sell your original 500 shares of ABC for a loss. You won't have a wash sale. And you will wind up with the same holdings in your portfolio.

"To use this strategy this year, you will have to double your position on or before Nov. 28," said Sophie Beckmann, a CPA and financial planning specialist with A.G. Edwards. You can wait 31 days and sell by Dec. 29, the last trading day of 2006.

Taking Gains

Different strategies will be available if you have a net loss this year. Then you can take gains.

Say you have no short-term trades this year and a $30,000 net realized long-term loss. Suppose you have a short-term holding up $25,000. You can sell that and take t tax-free proceeds. You will have a $5,000 net loss, so no tax will be due.

After taking tax-free gains, you can reinvest in another security. You can even buy back the stock you've sold right away. Wash-sale rules don't affect gains you have taken.

By selling a stock at a gain and buying it back, you will increase your cost basis in that stock. This will reduce taxes you'll owe on a future sale.

Just be sure your tax savings will top the transaction costs you'll pay.

Copyright 2006 Investor's Business Daily, Inc.

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