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By Christine Benz | 09-19-2012 10:00 AM

Tactics for Tax-Gain Harvesting This Fall

Taking a capital gain this year on some securities could pay off for certain investors, even if capital gains rates remain at lower levels, says Pinnacle Advisory Group's Michael Kitces.

Christine Benz: Hi. I'm Christine Benz for Morningstar.com.

With capital gains rates set to head up in 2013, many investors are wrestling whether to preemptively harvest capital gains.

Joining me to discuss that topic is Michael Kitces. He is partner and director of research at Pinnacle Advisory Group.

Michael, thank you so much for being here.

Michael Kitces: Thanks, Christine. Great to be here.

Benz: So, Michael, first let's discuss what is set to happen in 2013 with capital gains rates?

Kitces: So, as we're scheduled right now, capital gains rates are set at 15% for people in the upper tax brackets and 0% for those in the bottom two tax brackets. That's scheduled to rise next year with what actually is the lapse of rules that have been around for almost 10 years, and we go back to basically the old rules. The old rules had a top capital gains rate of 20% and a bottom capital gains rate of 10%. So in essence the 15% rates go to 20% and the zeros go to 10%.

Now, the additional overlay we actually have on top of that from the Patient Protection Act is the new Medicare unearned income tax, which is a 3.8% additional tax on, essentially, portfolio income--it’s got a few other things in there, as well--that applies to people with more than $200,000 of AGI or $250,000, as a married couple. So, what we're looking at really becomes three capital gains brackets: a 10% bracket, a 20% bracket, and then a 23.8% bracket for people at the highest income levels.

Benz: OK. So, let's discuss what types of assets would receive this capital gains treatment. It's investment assets, but it's also home-price appreciation as well above a certain level.

Kitces: Absolutely. Ultimately anything that is going to get classified as a capital gain--really a long-term capital gain, so held for more than 12 months--anything that's going to get classified as a long-term capital gain and shows up on your tax return accordingly, is subject to these rates.

So, certainly that's anything we hold in our portfolio. That also can be even things like the sale of our personal residence. Now, the benefit we get for our personal residence is that special gains exclusion that says, the first $250,000 as a single person, or $500,000 to a married couple, of gains is excluded entirely; if it doesn't show up on our income, if it doesn't show up as a capital gain, it's not subject to the old rates or the new rates.

But certainly for some areas … although prices have come down, someone might have bought their house 20-30 years ago, saw a significant appreciation. If we had someone, say, who bought their house originally for $250,000 a long time ago, and it's now worth $1.5 million, and they have $1.25 million of appreciation, $500,000 can come out of that as a married couple, but the remaining $750,000 is actually still subject to capital gains, including the 10% and 20% brackets, including the potential 3.8% surtax.

Benz: OK. And short-term gains still taxed at your ordinary income tax?

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