Tax Strategies: Capital Gains and Losses

The tax treatment of your capital gains and losses generally depends on how long you hold the asset before selling it. Gains and losses from sales of assets held for one year or less are considered short term and are taxed at ordinary income-tax rates.

There are several long-term capital gains tax rates. The 15% maximum capital gains tax rate applies to sales of assets held for more than 12 months (0% for those in the 15% or lower tax bracket for 2009 through 2012). The 28% rate applies to depreciation recapture for certain real estate.

To calculate your year-end capital gains and losses, follow these steps in the order listed:

1. Determine net gains and losses within each capital gains tax rate.
2. Offset your net long-term losses against each category of long-term gain. Start with the long-term gain subject to the highest capital gains tax rate, and then proceed to the next highest tax rate, ending with short-term capital gain.

You may use net capital losses to offset up to $3,000 of ordinary income per year. Excess capital losses may be carried over to succeeding tax years until used.

When to Recognize Capital Gains
You may wish to postpone recognition of gains until next year and thereby postpone the tax liability. Conversely, you may decide that it is more beneficial to recognize capital gains during the current year. You may want to recognize capital gains this year if:

• The gains will be subject to a higher rate of tax next year due to a change in tax bracket or tax law.
• You need to offset excess capital losses.

Realizing gains when you have sufficient losses may allow you to recognize those profits tax-free.

Choosing Recognition This Year
If you recognize capital gains or losses this year, keep the following in mind:

Wash Sales
If you sell a security and realize a loss, the loss will be disallowed for tax purposes if a substantially identical security or an option to buy that security is acquired within 30 days before or after the sale. This rule also applies to the purchase and sale of substantially identical stock options.

Although the loss from a wash sale is not immediately recognized, it is added to the basis of the repurchased security. In addition, the holding period of the security sold at a loss is added to the holding period of the newly acquired security. As a result, the loss is deferred until the sale of the reacquired security.

The wash sale rule does not apply to gains. Taxpayers who want to realize gains this year may reestablish their positions immediately.

Tax Swapping
If you own a depressed stock and there is a stock within that industry that your Prudential financial professional believes will outperform your current holding, he or she may suggest a tax swap. (Tax swaps may also apply to bonds, unit trusts, or other financial instruments.) This may allow you to upgrade your portfolio and generate tax losses at the same time. The capital losses generated from a swap directly offset realized capital gains. There are several other advantages to a tax swap:

• You are not vulnerable to price fluctuations that may occur during the 31-day wash sale waiting period
• Your income is uninterrupted
• You get an opportunity to upgrade your portfolio while prices are still at a depressed level.

Postponing Recognition Until Next Year
If your financial objective is to postpone the recognition of capital gains or losses until next year, consider the following strategies:

Rules for Short Sales¹
If you anticipate a decline in the value of certain stock that you do not own, you can enter into a short sale of the stock. In a short sale, you borrow shares of stock with the obligation of returning identical stock to the lender. After selling the borrowed stock on the open market, you do not recognize gains until you cover your short position. Gains can be postponed to a subsequent year by purchasing identical shares at a lower price and delivering them to the lender. If the stock becomes substantially worthless, you recognize a gain as if the short sale closed.

• Short-against-the-box. The short-against-the-box strategy that allowed you to enter into a short sale for stock you already own and postpone your capital gain while locking in the current market value as your sales price has been effectively eliminated. Capital gains may be postponed to the next year if you qualify under an exception by closing the short sale with newly purchased stock within 30 days after the close of the tax year of the short sale and by holding the original appreciated stock unhedged for at least 60 days after the short position is closed. Please consult with your tax advisor.

• Collars. Certain collars may be used to hedge appreciated stock.