A fairly common tax planning tip is to try to net out your capital gains and losses at the end of the year, so that (ideally) you do not have a “net” taxable gain, especially not a net short-term capital gain since this would be taxed as ordinary income (as high as 35% for federal tax).
So the idea is that you take a look at your “realized” gains and losses for 2010 (taking into account any capital loss carryover from 2009) and if you have a net gain you then see if you have “unrealized” losses that you can use to offset this net gain.
It is important to remember the ordering rules for capital gains:
1) First offset short-term gains with short-term losses
2) Then offset long-term gains with long-term losses
3) Then offset short-term losses against long-term gains or vice versa, for a net gain or loss. Note: It is considered inefficient to use a net short-term loss to offset a net long-term gain since you are using an “ordinary” loss (max 35% benefit) to offset a long-term capital gain (maximum 15% tax).
Note that you need to be careful of the “wash sale” rules, that disallow any loss if you have purchased the same security within 31 days before or after a sale. So you can’t just take the loss and repurchase the same security, which potentially leaves you out of the market for at least 31 days.
So far, this is the standard advice for all US citizens. However, Dutch resident taxpayers (individuals subject to “Box 3” tax in the Netherlands) are able to take a credit for the Dutch taxes they pay to offset the US tax on capital gains. Therefore, there may be no additional “net” tax in the US after taking this credit, so the tax loss harvesting may not be necessary. In fact, foreign tax credits expire if unused for 10 years, so it may be beneficial to use them while you can. However, it is still preferable to not have a net short-term gain, since this would probably use more of your credits than necessary.
$100,000 of Net Long-Term Capital Gains
X 15% Tax Rate in the US
$ 15,000 of US tax before credits
– 15,000 Foreign Tax Credit (passive basket)
$ 0 Net US Tax
If you are unsure whether or not you have sufficient tax credits, of if you have credits that will expire in 2010, ask your tax advisor (or check your 2009 tax return, Form 1116 and related statements). Most individuals living in the Netherlands have plenty of “excess” credits at the moment, because they have been paying the 1.2% annual Box 3 tax since 2001, but their investment returns have been too low to utilize all of the tax credits generated. Note: Prior to 2001, there was no Dutch tax on capital gains.