Time to Consider Year-End Investment Moves

Taking time to make some strategic decisions before December 31 can help keep your portfolio on track and potentially minimize your April income tax bill.

Review and rebalance

A portfolio review can tell you whether it's time to adjust your holdings. If one type of investment has suffered, it might now be a lower share of your overall assets than you intended, and could represent a buying opportunity. The traditional way to rebalance is to sell investments in an asset class that has done relatively well and use the proceeds to buy others that will return your allocation to its intended balance. (Don't forget tax considerations before rebalancing.)

If you're uncomfortable selling assets that have performed well, you could direct any new investments into an asset class that now represents less of your portfolio than it should. Diversification and asset allocation don't guarantee a profit or protect against a possible loss, of course, but they're worth reviewing at least once a year. Your checkup can also help you decide whether it's better to do any rebalancing before or after December 31.

Consider harvesting losses

Examine the tax consequences of any capital gains or losses you've experienced this year. Though tax considerations shouldn't be the sole driver of your investing decisions, taking steps before year-end can help manage your taxes. If you have realized capital gains beyond any tax losses carried forward from previous years, you can sell losing positions—known as harvesting losses—to offset some or all of those gains. Any losses over and above the amount of your gains generally can be used to offset up to $3,000 of ordinary income ($1,500 for a married person filing separately) or carried forward to offset future gains.

Before selling an investment, consider how long you've owned it. Assets held a year or less generate short-term capital gains and are taxed as ordinary income. That tax rate could be as high as 35 percent, not including state taxes. Long-term capital gains on the sale of assets held for more than a year generally are taxed at lower rates: 15 percent for most investors, 0 percent for individuals in the 10 percent and 15 percent tax brackets (for 2009 and 2010).

Time trades carefully

If you're selling to harvest losses and intend to repurchase the same security, wait at least 31 days to buy it again. Otherwise, the trade is a "wash sale," and the tax loss will be disallowed. The wash sale rule also applies if you buy an option, sell a stock short, or buy it through your spouse within 30 days before or after a sale of the same security.

If you're considering purchasing a mutual fund outside of a tax-advantaged account, find out when the fund will distribute dividends or capital gains. Consider postponing action until after that date, which is often near year-end. If you buy just before the distribution, you'll face potential taxes on that money, even if your own shares haven't appreciated. If you plan to sell a fund, you may be able to minimize taxes by doing so before the distribution date.

Think about your cost basis

If you own a stock or fund and decide to unload some shares, your cost basis can affect your tax liability. You can use the average cost per share for a mutual fund. Or you could request that specific shares be sold—for example, those bought at a certain price. Which shares you choose depends on whether you want to book capital losses to offset gains, or keep gains to a minimum to reduce your tax bite. (This applies only to shares held in a taxable account.)

First-time Homeowner Tax Credit Extended with Important Changes

On November 6, 2009, President Obama signed into law the Worker, Homeownership and Business Assistance Act of 2009, which includes a provision to extend the first-time homebuyer tax credit originally created in July 2008 with the Housing and Economic Recovery Act. This extension applies for new homes purchased before May 1, 2010; for members of the military whose duties have taken them overseas, the credit extends until May of 2011.

The new legislation includes some important changes for those buying a home after it was signed into law. These changes include:

• Higher income limits now apply. The credit is reduced if your modified adjusted gross income (MAGI) exceeds $125,000 ($225,000 if married filing a joint return) and is completely eliminated if your MAGI is $145,000 ($245,000 if married filing a joint return).

• A credit of up to $8,000 will still apply to qualifying first-time buyers, and a smaller credit of up to $6,500 will now apply to families that have lived in their homes for at least five years and wish to purchase a new home.

• If you (and your spouse, if you're married) have maintained the same principal residence for at least five consecutive years in the eight year period ending at the time you purchase a new principal residence, you could qualify for a credit of up to $6,500 ($3,250 if you're married and file separately).

For more information and to decide if taking advantage of these new rules is for you, visit the White House’s Fact Sheet on the Worker, Homeownership and Business Assistance Act or the U.S. Department of Housing and Urban Development’s Web site for details on the original Housing and Economic Recovery Act.