QUESTION: I hear a lot about year-end tax selling of securities. What's the theory behind these transactions?
ANSWER: Investors will usually sell securities near the end of the year to generate a capital loss which can be used to offset other income and thus reduce their tax bill for the year.
Probably the most advantageous application of this technique is to use a long-term capital loss to reduce or eliminate a short-term captial gain.
Suppose, for example, you had sold some shares of stock last spring that produced a short-term gain of $1,000. ("Short-term" gain or loss results from sale of an asset you had owned for a year or less.)
If you don't make any other moves, the entire $1,000 will be added to other 1979 income to be taxed in full at your regular tax rate. But if you can now sell other securities to produce a $1,000 long-term loss, you get a substantial tax break. ("Long-term" refers to assets held for more than a year.)
If you had only the $1,000 loss without any corresponding gains, only 50 percent of the loss -- or $500 -- would be subtracted from your other income to produce a tax reduction.
But since you have the earlier $1,000 short-term gain we talked about, the long-term loss can be used in its entirety -- not just 50 percent -- to offset the full amount of the gain. So the so-called "tax-loss sale" results in wiping out the entire tax liability attached to the short-term gain.
One of the techniques used by sophisticated investors is switching within the same industry group. Let's say you're holding 100 shares of a utility stock that has gone down in price since you bought it -- but which you believe will recover, so you want to hold it.
If you were to buy the identical stock within 30 days before or after you sell the 100 shares, you would have a "wash sale" and the loss would not be deductible. But if you know of a comparable utility stock whose prospects appear similar to the one you now own, you can sell yours, buy the other, and register the loss for tax purposes.
There are some rules to watch. The holding period which determines whether a gain or loss on sale of stock is short-term or long-term is based on the trade dates.
But the date on which the tax impact occurs is different for a gain than for a loss. A loss is sustained on the trade date, but a gain isn't realized until the settlement date (five business days after the trade date).
So the last day on which to trade for a gain to affect your 1979 tax return in Friday, Dec. 21. But you can sell securities as late as Monday, Dec. 31 to establish a 1979 tax loss.
Q: I understand there is a change this year in the requirements for claiming a dependent on my tax return. Do you have any information?
A: You're right; there is one change in the rules for dependents. It's related to the increase in the amount of the personal exemption from $750 to $1,000.
For 1979 you may claim as a dependent a person who meets all the other tests and who had gross income of less than $1,000 during the year. Last year the income limit was $750.
As before, the gross income test is waived in the case of your child who is either under 19 or was a full-time student during part of at least five months of the year.
Q: How long can I wait to make my Keogh contribution and still claim it on this year's tax return?
A: You can make a 1979 deposit into your Keogh plan any time up to April 15, 1980. But the plan must have been established by Dec. 31, 1979.
So if you don't already have a Keough account from previous years, set up the plan within the next couple of weeks. You can do this with just a token payment, then deposit the balance April 15.
The rule for an IRA is a little easier. A qualifying taxpayer has until April 15, 1980 both to open the account and to make the deposit. In either case, be sure to advise the plan trustees when you make a deposit in 1980 that it is on behalf of 1979 earnings.