I’m sure that is probably not the best play (pun-intended) on Shakespeare you have heard, but that is the question I have been receiving quite a bit lately from clients. Essentially, should they take their capital gains now forcing the taxation of gains into the 2012 tax year, or should they only take gains necessary to keep their portfolio balanced and in line with their long-term goals and tolerance?

I find that for most investors the answer to that question is there is no reason to force gains into 2012. However, as with many issues when it comes to investing the correct strategy is the one that is best for your personal, and unique, situation. Often times, there isn’t a one-size-fits-all solution.

There are two main points that people are concerned about with respect to capital gains taxes right now:
1) The new Medicare Surcharge (3.8% tax on the lesser of investment income or Modified Adjusted Gross Income (MAGI) over $250,000).
2) The impact of the “Fiscal Cliff” on capital gains rates (elimination of the preferential 15% capital gains/qualified dividend rate established during the Bush presidency unless).

Both of these issues are certainly valid concerns, however, both parties have stated that for those earning less than $250,000 a year, they want no increases on taxes. Regardless of when the Fiscal Cliff is resolved it appears that this is one area where both parties agree.

As such, most investors have nothing to fear as long as their income is expected to be below that threshold. For those above the threshold, they could certainly use the anticipation of higher rates as further incentive to diversify highly-appreciated and/or concentrated single-stock positions. Anyone own any Apple that has now become a large portion of their portfolio? Now could be a good time to realize some of those gains if you expect to be impacted.

I also think a prudent move for investors who are above the $250,000 threshold is to put thought into how they can minimize their exposure to the Medicare Surcharge and potentially higher capital gains rates on an ongoing basis. The best way to do this is to reduce the taxable investment income that results from your investments exposed to taxes.

For money outside of IRA accounts, we typically encourage tax-efficient funds such as large-cap U.S. mutual funds that have a history of low distributions. Municipal bond funds that produce income exempt from Federal income taxes and potentially exempt from State income taxes as well would also be an investment to consider. However, keep in mind that investing in only those two areas would produce a fairly unbalanced portfolio even though it would be tax-efficient. I would suggest if you do not have other accounts such as 401(k), IRAs or Roth IRAs where you could invest money into the less tax-efficient areas of the market, that it is still wise to include those areas in your portfolio for diversification purposes and accept that your taxes are likely to be higher in the future as a result.

As always, if we can be of service in helping you address these concerns, please contact our office and speak with one of our knowledgeable and capable professionals.

Scott Whyte, AAMS®, Financial Advisor
Bloom Asset Management