Question

Discuss the pros and cons of the capital loss limitation rules. Why do you think these laws exist? What changes, if any, would you propose to these limitations?

Answer 1

1.YES These laws are exist

2.Pros and Cons of Annual Tax-Loss Harvesting

Many investors undertake tax-loss harvesting at the end of every tax year. The strategy involves selling stocks, mutual funds, exchange-traded funds (ETFs), and other investments carrying a loss to offset realized gains from other investments. It can have a big tax benefit.

But tax-loss harvesting may or may not be the best strategy for all investors for several reasons.

Newest Tax Rates

The Internal Revenue Service (IRS), many states, and some cities assess taxes on individuals and businesses. At times, the tax rate—the percentage for the calculation of taxes due—changes. Knowing the latest rates regarding investments helps you decide if tax-loss harvesting is smart for you now.

KEY TAKEAWAYS

• Knowing the latest rates regarding investments helps you decide if tax-loss harvesting is smart for you now.
• One of the best scenarios for tax-loss harvesting is if you can do it in the context of rebalancing your portfolio.
• One consideration in a given year is the nature of your gains and losses.

For 2020, federal tax rates on items potentially pertinent to harvesting include: the top rate for long-term capital gains, 20%; the Medicare surtax for high-income investors, 3.8%; and the highest marginal rate for ordinary income, 37%.1 2

Though all investors may deduct a portion of investment losses, these rates make investment losses potentially more valuable to high-income investors.3

Understand the Wash Sale Rule

The IRS follows the wash sale rule, which states that if you sell an investment to recognize and deduct that loss for tax purposes you cannot buy back that same asset—or another investment asset “substantially identical”—for 30 days.4

In the case of an individual stock and some other holdings, this rule is clear. If you had a loss in Exxon Mobil Corp, for instance, and wanted to realize that loss, you would have to wait 30 days before buying back the stock. (This rule can actually extend to as much as 61 days: You would need to wait at least 30 days from the initial purchase date to sell and realize the loss, and then you need to wait at least 31 days before repurchasing that identical asset.)4

Let's look at a mutual fund. If you realized a loss in the Vanguard 500 Index Fund, you couldn’t immediately buy the SPDR S&P 500 ETF, which invests in the identical index. You likely could buy the Vanguard Total Stock Market Index, which tracks a different index.

Many investors use index funds and ETFs, as well as sector funds, to replace stocks sold and not violate the wash sale rule. This method may work but can also backfire for any number of reasons: extreme short-term gains in the substitute security purchased, for example, or if the stock or fund sold appreciates greatly before you have a chance to buy it back.

Further, you cannot avoid the wash sale rule by buying back the sold asset in another account you hold, such as an individual retirement account (IRA).4

Portfolio Rebalancing

One of the best scenarios for tax-loss harvesting is if you can do it in the context of rebalancing your portfolio. Rebalancing helps realign your asset allocation for a balance of return and risk. As you rebalance, look at which holdings to buy and sell, and pay attention to the cost basis (the adjusted, original purchase value). Cost basis will determine the capital gains or losses on each asset.2

This approach won’t cause you to sell only to realize a tax loss that may or may not fit your investment strategy.

A Bigger Tax Bill Down the Road?

Some contend that consistent tax-loss harvesting with the intent to repurchase the sold asset after the wash-sale waiting period will ultimately drive your overall cost basis lower and result in a larger capital gain to be paid in the future. This could well be true if the investment grows over time and your capital gain gets larger—or if you guess wrong regarding what will happen with future capital gains tax rates.

Yet the current tax savings might be enough to offset higher capital gains later. Consider the concept of present value, which says that a dollar of tax savings today is worth more than additional tax you must pay later.

This depends on many factors, including inflation and future tax rates.

Capital Gains Are Not Created Equal

Short-term capital gains are realized from investments that you hold for a year or less. Gains from these short holdings are taxed at your marginal tax rate for ordinary income. The Tax Cuts and Jobs Act sets seven rate brackets for 2020, from 10% to 37% depending on income and how you file.

Long-term capital gains are profits from investments you hold for more than a year, and they're subject to a significantly lower tax rate. For many investors, the rate on these gains is around 15% (the lowest rate is zero and the highest 20%).2 For the highest income brackets, the additional 3.8% Medicare surtax comes into play.1

You should first offset losses for a given type of holding against the first gains of the same type (for example, long-term gains against long-term losses). If there are not enough long-term gains to offset all of the long-term losses, the balance of long-term losses can go toward offsetting short-term gains, and vice versa.

Maybe you had a terrible year and still have losses that did not offset gains. Left-over investment losses up to $3,000 can be deducted against other income in a given tax year with the rest being carried over to subsequent years.2

Tax-loss harvesting may or may not be the best strategy for all investors for several reasons.

Certainly, one consideration in the tax-loss harvesting decision in a given year is the nature of your gains and losses. You will want to analyze this or talk to your tax accountant.

Mutual Fund Distributions

With the stock market gains of the over the past few years, many mutual funds have been throwing off sizable distributions, some of which are in the form of both long- and short-term capital gains. These distributions also should factor into your equations on tax-loss harvesting.

The Bottom Line

It's generally a poor decision to sell an investment, even one with a loss, solely for tax reasons. Nevertheless, tax-loss harvesting can be a useful part of your overall financial planning and investment strategy, and should be one tactic toward achieving your financial goals. If you have questions, consult a financial advisor or tax professional.

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3.

Introduction - Proposed Changes to the Lifetime Capital Gains Exemption

The Department of Finance Canada has released their proposed changes aiming to close perceived income tax loopholes relating to the use of private corporations. Specifically, Finance has targeted strategies designed to multiply access to the lifetime capital gains exemption.

Ordinarily, when a taxpayer disposes of capital property, the taxpayer must pay tax on any resulting capital gain. However, if the property is eligible for the lifetime capital gains exemption by virtue of being either the share of a qualified small-business-corporation (QSBC share) or qualified farm or fishing property, then the gain may not be taxable by virtue of a deduction under Division C of the Canadian Income Tax Act. As of 2017, each individual is entitled to a cumulative lifetime deduction of $835,716 for QSBC shares or $1,000,000 for qualified farm or fishing property. A deduction amount claimed for QSBC shares will be counted towards the cumulative total deduction claimed for qualified farm or fishing property and vice versa. Some taxpayers, with the assistance of tax planning by Canadian tax lawyers, are able to arrange for their spouses and children or other non-arm’s length parties to hold interests in property eligible for the lifetime capital gains exemption. Since each individual is entitled to their own lifetime cumulative deduction, splitting a capital gain between multiple individuals so that each individual can use up their cumulative deduction can significantly reduce the taxes owing on a sale of an eligible small business. This is called multiplying access to the lifetime capital gains exemption and is a well known tax reduction strategy. Structures designed to enable this outcome often use trusts when some of the individuals accessing the lifetime capital gains exemption are minors or not involved in the business associated with the property.

The Department of Finance aims to limit multiplication of the lifetime capital gains exemption with three proposed changes. First, individuals will not be able to use the lifetime capital gains exemption for gains that accrued while they were less than 18 years old. Second, individuals will not be able to use the lifetime capital gains exemption for property held in trust for them or for gains that accrued while the property was held in trust for them, subject to a few exceptions where the department believes existing rules are already effective. Third, individuals will not be able claim the lifetime capital gains exemption on any income subject to the new expanded tax on split income. The primary impact of the third proposed change will be imposing a reasonableness test on the sale of some shares that would otherwise be eligible for the lifetime capital gains exemption.