BY JASON M. MORLEY
Taxes should be an all year event and not just on April 15th; one wrong decision throughout the year can be costly. I hope the below examples will encourage you to work with a CPA, financial planner or educated tax preparer throughout the year to be proactive in your tax planning process.
What a difference a day makes!
With the long term capital gains rate lowered to 15% (5% for those in the 15% tax bracket or lower), the timing of selling your stock can make a big difference if you are unsure of your holding period. Example. Steve owns 1000 shares of Laker Corp which he bought for $10 a share on January 1, 2003. Therefore, his total cost is $10,000. Steve decides that Laker Corp. is no longer a great investment and decides to sell his shares on December 31, 2003 without professional advice. Steve has a great job and makes handsome salary*, which put him in the highest tax bracket of 35%. The values of his shares on December 31st were now worth $12,000, which is a respectable return of 20%. The taxes dues on this sale would be based on his nominal tax rate of 35%, which is a total tax of $700. If Steve sought out professional advice, he would have been told to hold his shares just one more day, and he could have saved $400. Short-term capital gains (those held for 12 months or less) are tax at your nominal (normal) tax rate based on your income. Long term capital gains (those held for 12 months and a day or longer) are taxed at a maximum of 15% and in this case a tax bill of $300 rather than $700 would be due, If he only sought professional advice, what a difference a day makes!
Bye, Bye New Home
Suppose you have just settled into your dream home and then suddenly the news comes that your new job which supports your dream home has been terminated. So what is your family to do, move? So you and your family pack up everything and relocate to wherever your new job may be, perhaps India? But when tax time approaches, you have to deal with the gain on the sale of your dream home. Or do you? When you originally purchased your dream home, the purchase price was $400,000. But when you sold the home just one year later, the value had risen to $500,000. This nets a healthy return of 25%, which is not that uncommon over the past three years of real estate returns on Long Island. But most of all, you will be stuck with a gain of $100,000 which would normally taxed at 15% as a normal long term capital gain. However, many of you may already be aware of the homeowner exclusion of the gain on sale of your personal residence. If you aren't aware of this, if you've owned your home for two of the previous five years and it was your primary residence you may exclude from taxation up to $250,000 for singles and up to $500,000 if married filing jointly. In the above referenced case, the homeowners only owned the home for a year and therefore they don't meet the above two year requirement. But Uncle Sam has come to the rescue. In late 2002, the IRS issued new guidelines on how to sell and get a pro-rata portion of tax-free gain if you reside in the property for less then 2 years. The key is "unforeseen circumstances." If you live in the home for less then 2 years and must sell for reason due to a change in employment or self-employment, multiple births from the same pregnancy, involuntary conversion of your home (town takes home to build a highway),divorce or separation, man-made disasters or acts of war, you can pro-rate the gain. This means in the above example, because the home owners who are married, owned the home for half or 50% of the two year requirement, and unforeseen circumstances caused the sale of the home, they would be allowed to exclude 50% of the allowable gain as if they resided in the home for the required two years. A normal sale would allow the couple to exclude up to $250,000 each or $500,000 for a married couple filing jointly if held for two years. The example of "unforeseen circumstance", allows the couple to exclude 50% of what they would otherwise be able to exclude or $250,000 ($500,000 x 1/2). So in this case, instead of a tax bill of $15,000 ($100,000 gain x 15%), this family can take there gain tax free and apply the extra money on therapy for the family because they had to move to India so the father can get his tech job back. These are two example of why you should seek professional advice throughout the year.
* over $319,100 for a single & married individuals
Jason M. Morley, CPA/PFS, CFP is founding principal of Morley Financial Planning, a Fee-Only financial planning and Registered Investment Advisory firm headquartered on Long Island in Suffolk County New York. The firm specializes in providing financial planning and investment advice to people from all walks of life. For more information you can contact Jason at 631-454-9444 or visit his Web site at