Some Tax Tips for Hedged Clients in the New Year!

by Wayne Ferbert on January 31st, 2013

Tax season is upon us and while we are not tax experts, some smart tax moves are just part and parcel of the Buy & Hedge experience. So, I wanted to remind you of a few of them:
1.     If you sold any stock to harvest a loss in late 2012 and replaced the position with a deep ITM call option, you can consider now rolling back in to that equity position. This is a tactic we write about in our book. You use it to harvest a loss, avoid the wash sale rule, and still stay exposed to the stock’s potential appreciation. You would use this tactic to avoid the wash-sale rule which requires you to exit the stock for 30 days. Now that it is the 31st of January, any sale in 2012 would no longer be wash sale eligible.
The last 30 days have been very good in the markets so hopefully, if you harvested a loss, you used this deep ITM call technique to stay exposed to the stock. But it is time to get back in to the stock if the stock is a dividend payer and its ex-dividend date is coming soon. It is also just important because a long call has a naturally decaying time value that is reducing its price. Time to look at closing those call positions and rolling back in to the stock. We talk about this tactic in our book.
2.     In our book, we write about the advantages of using Section 1256 contracts. The futures index options like SPX, NDX, & RUT are examples of Section 1256 contracts. They are popular and get special treatment at tax time: gains are taxed at 60% long-term rate and 40% short-term rate. We also write about this in our book.
But one thing we don’t write about in our book is the tax loss carry-back feature that these products offer. If you have a loss for 2012 in total for your section 1256 contracts, you can carry that loss back for up to 3 years (2009, 2010, or 2011 returns) and re-claim taxes paid on gains. However, you can ONLY re-claim the taxes from the NET GAINS you had on ONLY section 1256 contracts in those years. It doesn’t carry back to ALL gains – just the gains on these same types of investment vehicles.
Why is this relevant now? Some of you might be using these investment vehicles to hedge and more than likely these hedges lost money in 2012. These losses might be better off being carried back than using them in this year – depending on your tax situation. It is just one more way that these investment vehicles offer improved tax efficiency.
3.     Lastly, the run-up in the market has been impressive and has continued to be strong here in early 2013. If you know you had a great 2012 (most of you probably did given the market returns) and you expect to owe a tax bill, think about maybe making your re-balancing transactions now. You can take some gain off the table by selling your over-weight positions and get back in to allocation alignment. Then save that money to pay your tax bill. The markets are near 5 year highs so looking to take some gain off the table now (especially if you know you need to pay your tax bill) makes a lot of sense.
Hope these tax considerations give you some good ideas for managing your tax efficiency in the new year!

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