This year's down market has an upside. By selling losers, you can reduce your taxes, prune away unwanted securities, and reposition "tax-ugly" investments.
This year’s down market has an upside. By selling losers, you can reduce your taxes, prune away unwanted securities, and reposition “tax-ugly” investments.
Remove “tax-ugly” investments from taxable accounts. “Tax-ugly” investments throw off high, fully taxable dividends, and whenever possible should be held in tax-deferred accounts. For example, if you own a losing bond fund or a real estate investment trust (REIT), you can sell it and buy a similar investment in your IRA or 401(k) plan. (See below for precautions about wash sales—a gray area here.) This can transform the “ugly” into a thing of beauty while preserving your asset allocation.
Offset your gains with losses. If you sold your winners, such as energy stocks, this year, you face higher taxes. You may own a mutual fund that paid high capital-gains distributions. You can offset such gains with corresponding losses. If you have, for instance, $10,000 in long-term gains and can take $10,000 in long-term losses, they’ll cancel each other out.
Prune your portfolio of investments that no longer play an important role in the structure of your total portfolio—and get a tax benefit at the same time.
But plan carefully:
• Consider saving some potential tax losses for next year. The capital gains tax rate may be higher in 2009. Since the top long-term capital gains rate is now 15%, you can write off only 15% of your long-term losses. But if the capital gains rate were to increase to, say, 20%, your losses would become one-third more valuable.
• You can use up to $3,000 in net losses in any one year. Any amount above that has to be carried over to the next year. If you have big losses this year, that’s another argument in favor of waiting to sell some of your losers in 2009.
• Don’t put the tax cart before the investment horse. Tax consequences are an important investment consideration, but not the only one.
• You can’t sell an investment at a loss and buy it back within 30 days. That will trigger “wash sale” rules that would nullify the tax loss. Replacing it with a similar but not identical security avoids that problem.
• You can’t generate tax losses by selling securities held in tax-deferred accounts like IRAs.
• Consult a tax professional or qualified financial planner for advice.
Christopher P. Parr is co-author of Inside the Minds: Building a $1 Million Nest Egg. Columbia, MD-based Financial Advantage provides personal financial planning and investment-management services to retirees and aspiring retirees on a fee-only basis. Wealth Manager magazine has named Financial Advantage as one of the top 200 independent financial advisory firms in the country. Web: www.financialadvantageinc.com.