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You must ACT NOW to use your INVESTMENT LOSSES to generate TAX SAVINGS.Nov 21 '01 Write an essay on this topic.The Bottom Line After the long bull market, many investors are experiencing significant investment losses for the first time. You must act before year end to turn these losses into income tax savings. Right now is the time to turn your investment losses into tax savings for tax year 2001. You can save about $275 in taxes for every $1,000 in investment losses (assuming you are in the new 27.5% tax bracket), but you must act soon. Capital Losses Let's say you invested $10,000 in Cisco (or pick your favorite loosing stock) and then sat back and watched as the value of your investment plummet to $4,000. If you still own the stock, you are sitting on an unrealized capital loss of $6,000. You could just hang onto the stock, hoping that eventually the price will increase again, or you could sell the stock and pocket about $1,650 in tax savings on your 2001 taxes (assuming again that you are in the 27.5% tax bracket). Tax Treatment of Capital Losses First, in order to deduct a capital loss in a given tax year, you must actually realize the loss--that is, actually sell the stock--on or before the last business day of that year. In 2001, your last chance will be December 28. In the past, the date of record for tax purposes was the settlement date, which is a few days after the sale date, but the latest Tax Court rulings have established the sale date as the date of record. [Thanks to Arthur Rubin for the latest facts.] Second, you've got to be careful about the amount of your realized capital losses because there are limits on how much you can deduct. First off, you can offset any amount of realized capital gains against any amount of realized capital losses. Then, if you have left over capital losses, you can use them to offset ordinary income, but you can only offset $3,000 of ordinary income in this way. The excess capital losses don't help you this year, but they may be carried over to future tax years. Example. Let's say you sold a great performing stock at a profit (capital gain) of $5,000. Unfortunately, you sold another stock at a loss of $10,000. On your tax return, you can offset the $5,000 gain by $5,000 of the loss. You can then use another $3,000 of the loss to offset your ordinary income. In this case, there are $2,000 of losses you cannot use this year, but you can carry them over and use them next year. You could have chosen to sell only enough of the losing stock to realize $8,000 of the loss, in which case all of the loss would be deductible this year. Of course, you would still own some of the loosing stock. Wash Sales Now you're probably saying "Hey that sounds good. I know Cisco (or whatever) is eventually going to skyrocket, so I can make a double killing by selling the stock to get the tax advantage of a capital loss and then just buying back the same amount I sold in anticipation of the future increase in value." That's a great strategy except for one little problem: the IRS's "wash sale rule," which says that any purchase of a security within 30 days before or after the sale of the same security negates the realized loss for tax purposes. So, if you sell your Cisco stock at a loss and buy it back a week later, as far as the IRS is concerned, you never sold it, and you're not entitled to deduct the capital loss. If you intend to buy back the stock, the easiest thing to do is just sell it and wait 31 days before putting in your buy order for the same stock. Another tactic is to sell the stock and immediately buy a different stock with substantially similar future prospects. For example, sell your Merck shares and buy Pfizer. You can do something similar with mutual funds, for example, sell your shares of Vanguard's S&P 500 index fund and buy Fidelity's S&P 500 index fund. If you must buy back the identical stock, your broker should be able to offer you some advice about more complex strategies you can use to skirt the wash sale rule. Be Careful Before buying or selling any investment for tax purposes, you should ask both your broker and accountant to review your strategy.  |
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