Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, May 22, 1995 TAG: 9505230013
SECTION: MONEY PAGE: 8 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
You may want to lock in some of your profits by cashing in your investments. But before you act, consider that Congress is considering legislation that would significantly lower the capital gains tax for individuals, the portion of your profit that you hand over to the tax collector. This suggests that you may want to wait for the outcome of tax law changes.
But suppose the market suddenly should drop in the meantime?
Many people are in such a quandary today.
The capital gains tax bill passed the House on April 5, but it is stalled in a committee of the Senate, according to the office of Rep. Bob Goodlatte, R-Roanoke.
A spokesman for the Senate Finance Committee said that no hearings have been scheduled on the measure and no dates set for moving the legislation forward.
The current tax on capital gains is 28 percent, which is lower than the upper tax brackets. The ``Contract With America'' Tax Relief Act would create a capital gains rate that ranges from a low of 7.5 percent to a high of 19.8 percent, depending on an individual's tax bracket, said J. Patrick Budd, a certified public accountant with the Roanoke firm of Budd, Ammen & Co.
As the bill now stands, its provisions are retroactive to Jan. 1. That would seem to protect anyone disposing of stocks or mutual fund shares now, but Budd said the longer the bill languishes, the less likely the survival of that feature.
"However, by the time all of the fighting is done over this bill in the Senate," Budd said, "there is no guarantee that any future change in the capital gains tax structure will be retroactive."
Therefore, Budd said, many clients of his firm "are playing a waiting game that may result in a reduction in the value of the stocks by the time the tax laws change."
What can you do about it?
T. Michael Smith of Ferguson, Andrews & Associates said people should wait until the law is passed, "if you can," before taking any action.
But, Smith warned, "I would never let a tax decision be the only criterion on whether to take a profit" in the stock market.
"You can't go broke taking a profit," Smith pointed out. If investment guidelines suggest taking a profit now, he would do it irrespective of a change in the tax code.
Another suggestion, by Bill Nash, manager of the Roanoke office of Scott & Stringfellow Inc., is to base the decision on your own political sense of what Congress might do.
If you feel confident that Congress will reduce the capital gains tax, Nash said, then it would be wise to wait until the law is passed.
If you lack such confidence, he said, you might decide to sell your shares now.
Nash said the reduction in the capital gains tax is most important for people who have held stocks for a long time, not for the casual trader. Those who have major gains over many years, riding out the ups and downs of the market, will benefit most from a reduction in the tax, he said. He would advise such people to wait and see what happens to the law.
With the market so high, someone who has only a nominal gain from a recently purchased investment might want to sell regardless of the tax, Nash said. Under those circumstances, he said, "I'm not sure I'd let the tax enter into the picture too much."
Budd said some classic stock market moves might help some people out of the dilemma.
One method he recommends is called "short sale against the box."
Using this technique, you borrow from your broker shares of the stock you want to sell. You sell them immediately for their market value. In this case, you do not recognize the gain for tax purposes until you close out the short sale, meaning when you deliver your original shares to the broker to cover the ones that you borrowed.
If a capital gains cut has been enacted when the short sale is closed out, Budd said, you not only have deferred the gain but also have lowered the tax on the gain.
There are two risks in such a transaction: It assumes that Congress has not excluded such a maneuver when it passes the tax act; you also would suffer economically if the stock rose in value by the time you closed out the short sale.
Budd said special rules prevent you from converting a short-term gain into a long-term gain. A gain from a short sale is short-term capital gain if the taxpayer owns substantially identical property held for not more than one year on the date of the short sale or if the taxpayer acquires substantially identical property after the date of the short sale and on or before the closing of the short sale.
Any loss resulting from closing a short sale is long-term capital loss if, on the date of the short sale, substantially identical property has been held by the taxpayer for the long-term holding period. The holding period of property used to close the short sale is irrelevant, Budd said.
A second technique is called buying puts to protect gain.
Budd said a put option means a buyer pays a premium to acquire the right to sell to the option writer, at any time before a specified future date, a stated number of shares at a specified price. The writer of the put receives the premium and must buy the underlying stock for the agreed-on price if the buyer exercises the put.
In this case, the gain on the sale when the put is exercised is reduced by the premium paid.
The only real risk in this arrangement, Budd said, is losing the premium paid if the buyer lets the put expire.
by CNB