Cut Your Tax Bill By $840 Or More!

| December 8, 2009 | 0 Comments

I just looked at my calendar and was amazed at what I saw.  Only 17 trading days left in 2009.  I can hardly believe another year has come and gone.

Where did all the time go?

I started wondering, do I have enough time to get everything done before the holidays?

I’ve got several work projects to complete before year-end.  I still need to do all of my holiday shopping.  And, I’ve got to get my home decorated.

Don’t get me wrong, I love the holiday season.  It’s just that December always feels like such a pressure cooker.  (I’d bet dollars to donuts you know what I’m talking about…)

On top of everything else, I have one other important thing to do before the ball drops on New Year’s Eve.  I need to harvest some tax losses from my portfolio.

Every December I take some time to review the taxable investments in my portfolio.  Specifically, I’m looking for capital losses I can realize.  You see, capital losses can be used to offset any capital gains booked during the year.  And, any excess capital losses can be saved to offset future tax liabilities.

Now, I’m not a CPA or tax professional.  But, I do use a tax-loss harvesting strategy in my own portfolio.

If you’re in a high tax bracket, you should be doing this with your own portfolio.  You work hard for your money.  There’s no reason to pay any more of it to Uncle Sam than you absolutely must.

Too many investors foolishly hang on to losing stocks hoping they’ll eventually rebound.  I understand it’s tough to take a loss, but failing to manage tax exposure can seriously hurt long-term performance.

Here’s what you need to do.

First, you should look to offset any short-term capital gains.  These are gains from the sale of equities held for less than twelve months.  You can reduce or completely eliminate these gains by selling any equities showing a short-term loss.

This is very important.

You see, short-term capital gains are taxed at your ordinary income tax bracket… this could be as high as 35% in 2009.  And, tax rates are probably heading higher in years to come.  (Remember, the government still has to pay for the stimulus, bailouts, two wars, and possibly universal healthcare.)

In contrast, long-term gains are taxed at a much lower 15% rate.  These are gains from the sale of equities held for more than one year.  These too can be reduced or eliminated by selling any equities with a long-term loss.

Because long-term capital gains are taxed at a much lower rate, you want to push your net gains into the long-term category.  You see, net short-term gains and losses will be netted against long-term gains and losses.  The end result is either a net long-term or net short-term capital gain or loss.

I know this sounds complicated… let me give you an example of how harvesting tax losses can cut your tax bill by $840 or more.

Suppose you sell your losing trades and end up with a net capital loss (long-term or short-term).  You can use up to $3,000 of the loss to reduce your ordinary income (like income from your job).  If you’re in the 28% tax bracket, a $3,000 loss will save you $840 (0.28 x $3,000 = $840) in taxes.

Now, what happens if your net losses are higher than $3,000?

No need to worry.  You can carry your losses forward into future tax years.  In other words, you can use losses taken this year to offset any capital gains you take in future years.  And of course, you can use up to $3,000 of these carried forward losses per year to offset your future ordinary income.

If you sell a holding for a loss, you need to be careful about buying it back later.

The IRS “Wash-Sale Rule” disallows a loss deduction if within 30 days of the sale you buy substantially identical securities (or a put or call option on such securities).  For example, if you sell your Citigroup (C) shares on December 8th, you must wait until after January 7th to buy them back.

The wash-sale period is actually 61 days… 30 days before and 30 days after the sale.  And, as you can see from the example above, this period extends into the next tax year.

Many investors don’t want to sell a stock because they’re afraid of missing a rally in the stock or sector.

Fortunately, there’s a simple solution to this problem.

You can buy an exchange traded fund (ETF) that provides exposure to the sector in which you sold the stock.  If you sold Citigroup, for example, you could buy a financial sector or money-center bank ETF.  Either one would enable you to participate in any bank stock rally that occurs during your wash sale period.

Another solution is to buy shares in another stock within the same industry.  Continuing with your Citigroup example, you could buy shares of Bank of America (BAC), Wells Fargo (WFC), and/or JPMorgan Chase (JPM).

What constitutes “substantially identical” securities is somewhat of a gray area.  It’s best to consult with your tax adviser before you place any trades.  Make sure the security you plan on buying is not substantially identical to the one you sold.

As you can see, tax-loss harvesting is a great way to purge losers from your portfolio while simultaneously lowering your taxes.  Don’t miss out on the potentially huge tax savings from this under-utilized strategy.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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