It’s not only what you do that counts. It’s also when you do it.
Good timing could be especially important for many mutual-fund investors thrilled by this year’s strong stock-market gains and considering major new investments in stock-market funds for their taxable accounts before year-end. It’s easy even for sophisticated investors to overlook what can be an unpleasant tax problem—one that typically can be avoided with smart timing.
Taxpayers might have many other important timing issues to consider if Congress approves historic tax increases in coming weeks. But since our crystal ball is in the repair shop and nobody we’ve met knows for sure what lies ahead, those topics will have to wait for another day. Meanwhile, here is advice from tax and investment pros on the mutual-fund issue and a few other topics that could benefit many taxpayers.
With stock-market indexes having surged again this year, this is a good time for our annual reminder of why many investors might benefit by doing some research into year-end capital-gains distributions planned by mutual funds, especially stock funds. “It appears that big capital-gains distributions will again be an issue” for many fund investors, says
director of personal finance and retirement planning at
Before investing in a fund for a taxable account, look into whether the fund is planning a large capital-gains distribution later this year—and, if so, when and how large it will be.
Here’s why this can be important: Mutual funds typically distribute their realized net capital gains to investors late each year, usually during November and December. Check out their websites for details. If you’re investing for a taxable account, these payouts typically are subject to tax—even if you bought those shares shortly before the date to qualify for the payment. (This isn’t an issue for investments in tax-favored accounts, such as an IRA.)
So, if a fund is planning a large payout that would increase your tax bill significantly for this year, consider waiting to invest in that fund for a taxable account until after the date to qualify for the payment. Or think about other options, such as buying the fund in a tax-favored account or diving into a different fund that wouldn’t result in a big tax hit. For more thoughts on this subject, see this backgrounder by
T. Rowe Price.
Among those who have followed this issue closely for many years is
president of MILE Wealth Management in Irvine, Calif. Mr. Wilson has information on distributions on his website, including a “doghouse” list of funds planning especially large payouts as a percentage of net asset value. Early reports indicate that 2021 will be a significantly bigger year for large distributions than in recent years, Mr. Wilson says. As he points out, getting such a hefty distribution might sound wonderful, but it could also create a surprising tax bill for many unsuspecting investors.
Last year, limits on how much of your cash donations could be deducted were temporarily suspended, says
Mark A. Luscombe,
principal federal tax analyst at Wolters Kluwer Tax & Accounting. (Cash includes such things as checks and credit cards.) That change, which applies to 2021 as well, generally allowed donors to deduct qualified donations totaling as much as 100% of their adjusted gross income. Previously, there were limits that typically ranged from 20% to 60% of AGI and varied by the type of contribution or the type of charitable organization. Gifts to donor-advised funds don’t count for this provision.
This could be an important change for donors who want to make especially large donations, Mr. Luscombe says.
A few other reminders regarding giving:
• When donating stocks and other securities to charity, many investors who itemize their deductions donate “highly appreciated” securities that they’ve owned for more than a year and that have soared in value. Warning: Don’t donate securities that have declined in value since you purchased them, says
a certified financial planner at Summit Financial LLC in New Jersey. Instead, think about selling those losers—creating valuable capital losses that can help trim your taxes—and donating the proceeds to charity. For more ideas on charitable giving and background on capital losses, see my September column.
• Pay attention to the fine print on how to document donations. Most charities I’m familiar with do a fine job of sending their donors the required acknowledgments, which can be very important to have if you are audited. But a few smaller organizations sometimes don’t provide such acknowledgments. Here is just one example: Suppose you donate more than $75 to a charity. If you didn’t get anything in return, such as a free dinner or tickets to a popular sporting event, the charity typically is supposed to make that clear. I recently received an acknowledgment from a charity that didn’t include those key words, and I had to ask for a new one, which I received.
• If you did get something in return, the charity typically is supposed to estimate the value of what you received and inform you that your deduction generally is limited to the excess over the value of the goods and services the charity gave you. This can be tricky. The IRS offers this example: Suppose you donated $100 to a charity that gave you a concert ticket valued at $40. That is known among tax geeks as a “quid pro quo” gift. The IRS says the charitable contribution part is only $60. “Even though the part of the payment available for deduction does not exceed $75, a disclosure statement must be filed because the donor’s payment (quid pro quo contribution) exceeds $75,” the IRS says on its website.
There are exceptions to this rule, such as when the goods or services that a charity gave you are of “insubstantial fair market value.” Examples would include such token items as bookmarks, calendars or mugs bearing the organization’s name or logo.
IRS Publication 526 has many more details on charitable giving.
The 14-day rule
This isn’t new but often surprises readers: If you rent out your home for 14 days or less each year, the rental income you receive isn’t taxable. Those 14 days don’t have to be consecutive, either. This is an especially well-known break in many high-rent places, such as the Hamptons in New York. But if you rent out the home for more than 14 days, the entire amount is taxable. Keep good records.
Mr. Herman is a writer in California. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to email@example.com.
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