COLUMN-Seeking tax losses in a winning year

Mon Nov 25, 2013 8:00am EST

By Amy Feldman

NEW YORK Nov 25 (Reuters) - Investors who bet on the U.S. stock market have done very well this year - the Standard & Poor's 500 stock index is up more than 25 percent since 2013 dawned.

That might make the average investor think there is no point in trying to look for losing investments to sell for tax purposes, typically a smart year-end tax strategy. But it would be a mistake to not at least look for losers.

After all, not every stock or fund or strategy is up this year, and it is likely you have at least one clunker in your portfolio.

Perhaps you own an emerging markets fund. They have been extremely volatile, and as a group are down nearly 1 percent so far this year, according to Morningstar.

Or maybe you bought Apple Inc stock for $700 back in September 2012, and now you have lost more than one-quarter of your money. Or you came late to a diversified bond fund, heavy on the Treasuries, that has been struggling, and you own shares that are under water.

As Debbie Cox, managing director of JPMorgan Private Bank in Dallas, puts it, "It would be unusual for any investor to not have some losses."

As long as they are not tucked away in tax-protected retirement accounts, those losses have value at tax time. But to take advantage of them, you need to sell before year-end. That way, when you are preparing your 2013 income tax return next year, you can offset your investment gains with your losses, and take an additional $3,000 net loss against your ordinary income. If you still have losses left over after that, you can carry them forward to use in future tax returns.

Studies have shown that such tax-loss harvesting - particularly when done throughout the year - adds to returns. But this year, it is even more important than usual for two reasons.

First, given the market's rise, you probably do have gains. Even if you have not sold winning stocks, it is likely that the stock mutual funds you own will post taxable gains for the year. It is also likely that you have run out of losses that you have been carrying over since the 2008-2009 financial crisis.

Second, if you are an upper-income taxpayer, you may be paying taxes on your investment gains at a higher rate. There is a new 3.8 percent net investment income surtax that kicks in for joint filers who earn above $250,000 and for singles earning more than $200,000. And the long-term capital gains rate has gone to 20 percent from 15 percent for high-earners (married couples who make above $450,000 and singles over $400,000). For those close to either of those thresholds, losses are particularly valuable.

In previous years, when those tax rates were lower, some advisers recommended waiting to take losses until a future year when they could be used to offset gains that would be taxed at a higher rate. With these higher rates, set by the so-called fiscal cliff tax agreement at the beginning of 2013, it is now that future year.

For those who hate to part with any of their portfolio's holdings in a rising market in order to take losses, JPMorgan's Cox points to an additional strategy: "Double up" by buying more of that stock or fund, and then selling the older shares that show a loss for tax purposes.

When you do that, you have to be aware of two constraints: (1) You have to identify and sell the correct shares to make sure you log the loss; and (2) You have to abide by the so-called wash sale rule, which prohibits buying or selling the same security 30 days before or after taking a capital loss.

If you want to double up without violating the wash sale rule, the last day to buy is Friday, Nov. 29 - the day after Thanksgiving. Then you can sell the losing shares on Dec. 30.

So while you are gorging on leftovers, take a few minutes to review your portfolio for its old turkeys.

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