There's a TD Bank branch in Seymour, Conn., that was robbed on Aug. 19. The thief handed the teller a note demanding money. The problem? The note was written on the back of his girlfriend's pay stub. Suffice to say, the police caught him. That would be like an investor evading tax on investment income but sending his statements to the taxman as part of the process.
Forget about tax evasion. If you're an investor, there are plenty of tax savings available by simply being smart. As we head into the last quarter of the year, investors should consider the following ideas related to capital losses to cut their tax burden for 2017.
Realize capital losses before year end
Will you have capital gains to report for 2017? Or perhaps you've reported gains in the past three years. If so, consider selling any investments that have dropped in value. Capital losses must first be applied against any capital gains in the current year, but excess losses can be carried back up to three years to offset gains in those years. Is it always worthwhile selling your losers before year end? Only if you have capital gains to offset or if you simply don't like the investment any longer. If you don't have gains, or you still like the investment, you'll save transaction fees by holding onto it.
Transfer capital losses to your spouse
If you have an investment that has dropped in value and have no capital gains to offset the loss, but your spouse has capital gains this year or in the previous three years, it may be possible to transfer your unrealized capital losses to your spouse. Here's an example: Jack and Jill are married. Jack owns shares of XYZ Corp. worth $10,000 today, although he paid $15,000 for the shares, so he has a $5,000 unrealized loss. Jill reported capital gains in 2016 of $5,000 and paid $1,338 in taxes. Jack would like to transfer his $5,000 capital loss to Jill, so she can carry the loss back to 2016, recovering the taxes she paid.
He can do this in three steps: Step 1, Jack will sell his XYZ shares. This will trigger a capital loss. Step 2, Jill will purchase, on the open market, the same $10,000 worth of XYZ shares. This purchase should take place within 30 days of Jack's sale. Now, the superficial loss rules in our tax law will kick in here. Those rules say that when you sell a security at a loss and then you, or someone affiliated with you, purchases the same security within 30 days of your sale or 30 days prior to your sale (a 61-day window, including the day of the sale) the loss will be denied.
Follow me here. Jack's loss is denied because Jill purchased the same XYZ shares within 30 days of his sale. But is that loss denied forever? No. The denied loss is added to the cost amount (the adjusted cost base, or ACB) of the newly acquired shares. This will result in a lower capital gain, or larger capital loss, when those shares are ultimately sold. So Jill has paid $10,000 for her XYZ shares, but her ACB is bumped up to $15,000 for tax purposes.
Finally, Step 3, Jill can sell her XYZ shares on the open market for their value, $10,000, but her ACB is $15,000, so she'll have a capital loss on her hands, which she can now use. But for the loss to be available, she must wait until the 61-day window has passed before she sells the shares.
Make a gift in the fourth quarter
You can give any investment that has dropped in value to your kids today. You'll be able to claim the capital loss in 2017. Your kids will be deemed to have acquired the investments at fair market value (this will be their ACB), so they can sell the investments (for reinvestment or spending) without a tax cost.
Claim an ABIL
If you've invested in the shares of, or have lent money to, a small-business corporation that is now defunct, you may be entitled to tax relief in the form of an allowable business investment loss (ABIL). This allows you to deduct one half of the amount lost against any type of income, not just capital gains. Speak to a tax professional about it.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices