To Harvest Capital Gains in 2012 or Not? That’s a Good Question.
This is the second in a four part series on pending tax legislation and how it can affect you.
John C. Scott, CPA/ABV, AEP, Tax Partner
For many taxpayers it will make sense to harvest capital gains in 2012 to take advantage of the current lower rates. You would sell appreciated capital assets and immediately reinvest in the same or similar assets. You would then hold the new assets until you would otherwise have sold them, so there would be no change in your investment strategy.
Deciding whether to use the strategy is not as simple as it might appear on the surface, however, because the lower tax rates must generally be weighed against a loss of tax deferral. By harvesting the gains in 2012 you would be paying a lower tax rate, but recognizing the gains earlier. The greater the differential in tax rates and the shorter the time before the second sale the more favorable gain harvesting would be.
In some cases, the correct decision will be clear without doing any analysis. If you are currently in the 0% long-term capital gains bracket, 2012 gain harvesting would always be favorable because it would give you a free basis step up. Gain harvesting would also be more favorable if you planned to sell the stock in 2013 or 2014 anyway. The time value of the tax deferral would be small compared with the future tax savings.
At the other extreme, if you are currently in the 15% long-term capital gain bracket and plan to die with an asset and pass it on to heirs with a stepped-up basis, there is no reason to recognize the gain now. You would be incurring tax now without any offsetting future benefit. Nor would it make sense to harvest losses to create additional capital loss carryovers. These loss carryovers would be better employed to offset capital gains in the future when rates are expected to be higher.
If you do not fall into one of these categories, you will have to do a quantitative analysis to determine whether 2012 gain harvesting would work for you. The decision could be thought of as buying a future tax savings by recognizing gain in 2012.
By analyzing the decision in this way, you could measure a return on the 2012 investment over time. If this return on investment exceeded your opportunity cost of capital, gain harvesting would make sense. We can help you determine the analysis best for you.
Be sure to come back Tuesday when I discuss the 3.8% Medicare Surtax.