Brokerage Firms Must Report Investment Gains; Plus S&P Downgrade

In an effort to ensure everyone pays their fair share of taxes, on January 1st of this year, the Federal government began requiring brokerage firms and other custodians to calculate and report gains or losses on certain customer trades to the IRS. This requires knowing not only the cost basis (the amount paid for the security), but also establishing the method to calculate gains. Most custodians use the “first-in, first-out” method for equities and the average cost method for mutual funds to determine cost basis.

You should consult your custodian to determine what methods are available to you and to determine how your portfolio is setup. For our clients we utilize a hybrid of the "high cost" method. We first try to determine if there are any trade lots that can be sold at a loss.  Once that has been done we sell the lots with the highest cost basis that are over 12 months old first.  This gives us the maximum tax efficiency on any trading in our client accounts.

Our portfolios’ tax-efficiency has always been a major concern. While many give up on tax loss harvesting in years when investors have not registered significant gains, the exercise is never a waste of time. Remember, harvested losses can offset any gains and up to $3,000 of net capital losses can be deducted from their ordinary income on their tax return for the year. Net losses above that $3,000 can be carried over to future years until they've all been used up by future portfolio gains.

As we expect capital gains tax rates to increase in the future, the tax loss harvesting approach makes even more sense. Simply, losses you book today mean gains that are otherwise likely to be taxed at a higher tax rate in the future could be tax free.

Utilizing “tax swaps” whereby we sell a losing position and simultaneously purchase a similar security (mindful of wash sales rules which prohibit selling and then buying the same security within 30 days) allows us to maintain exposure to the asset class while we harvest losses.

S&P Debt Downgrade:

Unrelated to this blog topic is the subject of Standard & Poor's downgrade of the U.S. credit rating from AAA to AA+.  This will be brief but as I mentioned to many, I felt investors and the media made more of this matter than what it deserved.  The U.S. dollar is still the global reserve currency and Standard & Poor's and others don't exactly have a pristine record when it comes to making accurate credit ratings.

On the lighter side, I wanted to share the formula below that a friend shared with me.  I don't know where he got it, and I am unable to give credit to the person who created it.  If someone knows who created it, I will gladly give them credit.  In the meantime, I hope you can enjoy the humor of it:


No offense is intended to be directed at the POTUS, Senate Democrats, House Republicans, Tea Party or Wall Street.  Just enjoy it!