Cutting Down on Capital Gains

Capital gains are typically the result of selling off good investments or assets that have increased in value. To your benefit, you can manage your capital gains and losses by determining the manner in which you buy investments and when you elect to sell them. By minimizing capital gains you can also

minimize the ensuing tax bite. One of the simplest ways to limit capital gains is to buy equities and hold them, thus not realizing the gains but keeping them on paper. Holding stocks over a period of time is typically good advice regardless of capital gains strategies.

Holding onto mutual funds, however, does not insure that you will be spared capital gains taxes. As the fund manager buys and sells within the fund, capital gains are generated and you may be taxed on the gains by the fund. Therefore, even if you do not sell the mutual fund shares you own, you may have capital gains taxes to pay.

To cut down on the capital gains generated by mutual funds you can purchase more aggressive mutual funds within your retirement plan, whereby they are tax deferred and not a problem in the immediate future. Then, in the non-retirement portion of your portfolio you can purchase the funds that do less trading, such as an index fund or a bond fund for the income. The capital gains generated through transactions within an index fund are minimal. Keep in mind that if you buy a mutual fund, it is also advisable to do so after the tax assessment is made. Otherwise, you can pay taxes on a mutual fund that hasn’t benefited you at all.

One of the rules of thumb, when it comes to capital gains, is that unless you have a loss sitting there to offset some of your gains, you should sell off smaller gains. To do this with your stocks, you will need to know which shares you purchased at which time. If for example, you purchased a stock at $12 per share, and later purchased more at $18 per share, when the stock hits $24 per share, you will have less of a capital gain by selling the shares purchased at $18 per share. To do this, you must keep very good records of when you purchased your shares of stock and at what price.

You’ll also want to wait and sell of shares of stock, or any investment, after holding it for more than one year, to benefit from the 5 percent lower capital gains tax rate. Once the investment passes the one-year mark, thanks to recent tax law changes, the capital gains tax is lower.

What about capital losses? You can actually benefit from your losses. If you see capital gains growing and you also have a losing investment, take the loss to offset your capital gains by $3,000 (which is the maximum you can deduct as a capital loss in one year). If it turns out that you have a major loss, you can spread that loss out of the next several years. For example, if you have a $15,000 loss in 2004, you can deduct $3,000 in 2005 and for each the following four years up through 2009.