Cash In Now On The Dow, Pay Uncle Sam Laterby
With the stock market now hovering around new highs, investors may be tempted to lock in capital gains. Those selling stocks for a profit can always offset gains with capital losses. But if you don't have much in the way of losses this year and prefer to pay taxes later rather than sooner, there are still ways to cash in current gains while postponing the tax on them until 1992.
This year, at least, investors don't have to contend with any significant changes in the tax laws. After offsetting capital gains with capital losses, individuals can still deduct up to $3,000 of net capital loss from ordinary income. Any amount over that level can be carried forward and used in future years.
With so many stocks benefiting from the surge in the market, however, some tax strategies make more sense this year. One popular technique investors can use is "selling short against the box." This allows you to lock in a current gain and defer taxation until 1992. "A lot of investors feel that their capital gains may be somewhat tenuous, that there could be a market correction," says Robert Willens, an accounting analyst with Shearson Lehman Brothers. "It's almost a perfect scenario for selling short against the box."
NEAT HEDGE. It works like this: An investor who already owns 100 shares of XYZ Corp. borrows another 100 shares from a broker and has the broker sell them immediately. In stock market parlance, the investor has made a "short sale." When it's time to return the 100 shares of XYZ to the broker -- in 1992, of course -- the investor delivers the shares held in his or her personal portfolio (the "box"). The Internal Revenue Service doesn't consider the position closed and taxable until those "long" shares are delivered in 1992. If the shares appreciate after you sold the borrowed shares, you miss out on that extra gain. If the stock goes down, then your hedge has paid off.
If you want to hold on to a stock that already has gained in value but you're worried that it might decline, you can hedge your position by buying a "put" option. That gives you the right to sell 100 shares of the underlying stock at a set price within a period of months. The value of your puts will increase if the stock goes down. The option price on the put, called the "strike" price, would be slightly below the current share price. And you'd buy an option with an expiration date in January, 1992. For example, say you bought 500 shares of Johnson & Johnson earlier this year at $70 a share. The stock was trading on Nov. 8 at 96 3/8. You could buy five January 95 put options, essentially giving you the right to sell 500 shares of J&J at $95 a share. That would cost you $262.50 per option for a total of $1,312.50 plus commission. At Shearson, that commission would be $86, says Willens.
If the stock declined in value, say to 90, you could sell your puts to make up the loss of value in the shares you own. If J&J shares rise, say to 110, your puts will expire worthless, but your shares will have increased in value by $6,812.50, more than offsetting the cost of the hedge.
GO FOR GROWTH. Most advisers say now's the time to weed out underperformers. PaineWebber suggests moving into stocks with greater growth potential in the slow-moving 1990s. Among their pics: Switch from American Home Products, with an estimated growth rate of 10%, into Bristol-Myers Squibb, which is growing at an estimated 19%. Since PaineWebber projects similar price-earnings ratios in 1992 for the companies, "you're buying superior growth without paying a much higher multiple," says PaineWebber investment analyst Mary Farrell.
That would establish a gain or loss that might fit in with your tax needs. And you've preserved your stake in an industry. You'll run into snags if you try to take a loss on a stock you've owned for less than 30 days or if you buy the stock back before 30 days have passed from the day you sold it. The IRS would disallow such a loss under the "wash-sale" rule. Losses will also be denied for call options, warrants, or convertible issues that "substantially resemble" the stock. It's the IRS' way of reminding investors they can't have their cake and eat it, too.