Selling Investments in 2010 to Reset Your Cost Basis

A reader named Andrew recently wrote in with the following question about resetting your investment cost basis:

There is a chance the capital gains tax can increase to 20% next year, so I was wondering if I could sell my stock at a gain to book my gains at 15% tax for this year and reset the cost basis for next year.

I read IRS pub 550 and the wash sale definition only talks about selling at a loss. any thoughts here?

Andrew is correct that, unless Congress acts, the top rate for long-term capital gains will rise from 15% to 20% in 2011. This rate will apply to everyone aside from those in the two lowest tax brackets. At the low end, the 0% long-term capital gains rate of those in the bottom two tax brackets will rise from 0% to 15%.

Taking a step back, capital gains are calculate as the amount you sell an investment for minus your cost basis (what you paid for it). In essence, Andrew is looking to sell his investments right now, pay the lower current capital gains rate this year, and then re-buy everything, effectively resetting his cost basis to a higher value.

The advantage of increasing your cost basis is that your future gains will be lower (at least on paper) so when you eventually sell, you’ll have less gains exposed to the potentially higher tax rate. This is a good thing, but it comes at a cost.

What about the wash sale rule? The wash sale rule only applies to investment sales that result in a loss. In other words, you could sell at a gain and immediately re-buy in this scenario.

Should you reset your cost basis?

If it were me, I wouldn’t bother with this strategy unless I was in a very low tax bracket, and could sell a portion of my holdings and pay 0% LTCG taxes – just be sure you don’t exceed the threshold or you’ll wind up paying 15% on a portion of your gains. As for selling and paying 15% now instead of holding and possibly paying a higher amount later, no thanks.

Yes, I could avoid a bit in the way of taxes, but only by paying my taxes far in advance of when I’d otherwise have to pay them. I’d much rather continue deferring those taxes and letting my money work for me during that time as opposed to handing a portion of it over to the IRS this year, even at a reduced rate.

Another minor consideration is that by selling and re-buying, you reset the clock on your capital gains, and you will have to hold your investments long enough to once again qualify for “long term” treatment.

If anything, I would consider resetting our cost basis by donating appreciated assets instead of cash and then using the cash we would’ve donated to re-buy the investment. Of course, this only works if you’re already planning on making charitable contributions, but it’s worth exploring.

5 Responses to “Selling Investments in 2010 to Reset Your Cost Basis”

  1. Anonymous

    I have about a $10,000 carryover loss from previous years, and gains on purchases over the past year. Would it not make sense to reset the cost basis on these investments, since I will just be using the gains to offset that carryover loss?

  2. Anonymous

    I am considering selling some assets in our brokerage account and contributing the money to a 529 plan. If I was planning on doing so in early 2011 anyways, it probably makes sense to sell the assets this December and save 5%.

  3. Anonymous

    Thanks for answering my question! Your advice makes perfect sense since I don’t need the money in the near future.
    it was an emotional reaction to the possible tax increase that brought on the question.

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