| NEW YORK
NEW YORK Aug 16 Sometimes, it makes sense for
the tail to wag the dog. That's what experts call it - often
with derision - when investors let tax considerations drive
their investment decisions. Theoretically, you're only supposed
to make investment moves based on your investment goals.
But still, if you've been in the market for the last two
weeks, there's a good chance you have some sizable losses and
gains. With some strategic selling and buying, you can lock in
a tax break that will make you happy next April.
From a tax standpoint, "now is a good time to perk up the
whole portfolio," suggests Mary Kay Foss, a Danville,
California, certified public accountant. "But I think right now
most clients aren't listening to my advice. Some of my clients
are so shell shocked ... (by last week's market gyrations) ...
that they weren't ready to take action."
Here's what you need to know to make the most of those tax
breaks. If all of your investments are in tax-deferred
retirement accounts, you can stop reading now: The
gains-and-losses strategy won't apply to you.
LOSSES ARE VALUABLE
When you lose money on a long-term investment (one you've
held for more than a year), and you sell it, you "realize" the
loss. That means you can use that loss to offset any long-term
gains you've also realized. And you can use an additional
$3,000 of loss to reduce ordinary taxable income. If you end up
with more losses than that, you can carry them forward and use
them, year after year, until they are used up.
Short-term losses are even more valuable. That's because
short-term losses (those on investments held a year or less)
offset short-term gains, which are taxed at a higher rate than
long-term gains. Short-term gains are typically taxed at your
regular income tax rate, instead of the preferable 15 percent
rate applied to most long-term gains. You can use those
short-term losses to offset $3,000 in ordinary income, too, and
also carry them forward.
Being able to take a loss provides a serious selling
opportunity, Foss notes. Even though the overall market has
recovered from last week's big sell offs, you may still have
losses in specific investments. (Bank stocks, anyone?). And if
you locked in some losses, that affords you the opportunity to
sell winners, too. Say, for example, that you've been sitting
in a growth stock mutual fund and you'd rather be in a dividend
stock fund, but you were afraid to sell the growth fund shares
for fear of triggering a capital gain. You can use new losses
to cover gains you might realize when you rejigger your
"If you've got some losses that look solid, look at some of
those profit positions that you don't want for the long haul,"
says Foss. It doesn't make sense to wait until the end of the
year to make all of your portfolio adjustments if the tax
implications work now.
If your goal is to be invested, then don't sell your shares
and park your money on the sidelines. Otherwise, you could end
up locking in a tax loss and losing a bucket of money. Consider
those people who, for example, sold at the end of the day on
Monday, Aug. 8, when the Dow Jones Industrial Average dumped
624 points, and then failed to buy back in in a timely manner.
The following day the index was up 429 points. On Monday, Aug.
15, the Dow surpassed its pre-Aug. 8 high. That would have been
a costly sale.
Sell your shares to lock in your tax gains and losses, and
then immediately buy something different, so your overall
investment strategy remains in force.
Tax pros know all about the so-called "wash sale rule."
That prohibits investors from selling an investment to lock in
a loss and then turning around and buying the exact same
security immediately. You have to wait 30 days to buy back the
same shares. In most cases, you can instead buy something
similar, but different. Even an index fund that is a different
brand than the index fund you sold fits that bill. And beware
of mutual funds in which you are reinvesting dividends or
automatically investing money every month: The shares you
bought in the month before you sell will put you in violation
of that wash sale rule, too.
If you do run afoul of the wash sale rule, you won't go to
jail, you'll just lose the ability to take a loss. Instead, the
"loss" will get added to your original basis in the stock, so
you'll reap that benefit at a later date, explains Kaye Thomas
of www.Fairmark.com, a tax publisher. For example, if
you bought shares for $20, sold them at $10 and immediately
rebought them at $11, your new "basis" - the purchase price
used for calculating future gains and losses, becomes $21.
That's calculated by adding the initial "loss" to the new
The process is complex, but worth learning. At a combined
federal and state income tax rate of 35 percent, every $3,000
in extra losses will save you $1,050 a year. That's worth a
little homework, and some wag-the-dog strategizing, no?
(Editing by Beth Gladstone)