Cut Your Tax Bill By $840 Or More!
The Dynamic Wealth Report
December 8, 2009
by Robert Morris, Editor
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?
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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.
It’s going to be busy week in the IPO market. Seven companies are
expected to price and begin trading this week. The two most attractive
deals are scheduled for Friday. They are Chinese companies…
Linkage
Technologies (BOSS) and Concord Medical Services (CCM). Both companies
have seen revenue and net income more than double through the first nine
months of 2009.
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