No one wishes to lose money on an investment. But, if it happens to you, don’t let it get you down. You may be able to lower your tax bill to cheer yourself up.
The Bright Side
A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. The upside is that you can use capital losses to offset capital gains you realize in that same tax year.
When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately). Then you can carry the remainder forward to future years until it’s used up.
Wash Sale Rule
Years ago, investors realized they could sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses in situations where an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.
Waiting 30 days to repurchase a security sold at a loss is one way to achieve your goals without running afoul of the wash sale rule. But there may be times when you’d rather not be forced to sit on the sidelines for a month. Instead, you might consider doubling up on a position in which you have a loss and then waiting 31 days to sell the original stake — a strategy that also avoids a wash sale violation because the purchase occurs more than 30 days before the sale.
If you don’t want to sit on the sidelines or double up on a position, there’s often an alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Say you own stock in a networking equipment company that has lost value since you bought it. After researching the industry, you discover that the company’s chief competitor is more attractively valued and has better growth prospects.
Your solution is now simple and straightforward: Simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you’ve added toyour portfolio a stock you believe has more potential or less risk.
Seek Professional Advice
If you incur a capital loss, please contact us. We can discuss your options to use it to reduce your taxes and re-position your portfolio.
SIDEBAR: Mutual Fund Matters
In some cases, rather than invest in a single security, you may wish to identify a mutual fund or exchange-traded fund with a similar investment sector, strategy and size. If you’re buying mutual funds, however, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability.