Tax-loss strategies for those investment dogs
- By Milt x_Zall
- Dec 21, 2000
Seasoned investors know that you should not let the tax tail wag the investment
dog. That's not to say that your investments are dogs — it's just that taxes
should not dictate your investment decisions.
However, taxes can be somewhat of a factor in investment decisions, especially
if you are in a higher tax bracket with short-term gains.
This year, a down market has followed several stellar years, so you may
indeed have a few investment dogs in your portfolio. Here are a few ideas
from Dennis Filangeri, a certified financial planner based in San Diego,
on how you might use those losses to your advantage.
* Offset wins, losses
The most basic step is to simply sell taxable losing investments during
the same tax year you have taxable investment gains. For example, you can
sell losing stock to offset gains made from the sale of other stock or mutual
fund shares. Or you can sell the losing stock to offset taxable distributions
generated if your mutual funds have sold winners.
This strategy applies to most types of investment income, although income
from "passive" investments, such as rental real estate or limited partnerships,
presents unique issues we can't go into here.
For example, say you have $40,000 in capital gains from your winners, and
you've realized $15,000 from the sale of losing stocks and mutual funds.
If you are in the highest tax bracket of 39.6 percent, the losses would
generate a tax savings of $3,000 if the $40,000 gain was all long-term—
they would generate up to $5,940 if the $40,000 came from all short-term
What if you have a really bad year, and your losses exceed your gains? First,
offset all your taxable gains. You can then deduct up to another $3,000
in losses against ordinary income such as wages, interest and dividends.
Any losses you have left over can be carried into subsequent tax years to
first offset gains and then to offset ordinary income in those years.
* Washing up
What if you don't want to sell losing stock, mutual fund shares or other
investments to offset your gains? Perhaps you have stocks or funds that
you are confident will rebound. One scenario is to sell the shares and repurchase
the same ones 31 days later. This avoids the 30-day wash rule, which was
designed precisely so investors can't wipe out their gains with some quick
selling and buying.
The wash rule carries the risk that the asset you sell will rise in price
during the 31 days before you repurchase it. A strategy to avoid this is
to buy something similar, but not — according to the IRS — "substantially
identical." Usually this means you could buy another index fund or a similar
technology stock. Of course, you're not buying exactly the same asset, so
if you're in love with the asset you have, this strategy may not be the
The 30-day wash rule does not apply to selling winners, however, and you
may be able to use this to your advantage if your losses for the year exceed
your gains. This strategy calls for you to sell enough winners that you
weren't otherwise planning to sell. Then immediately buy new shares of the
same stock, bond or mutual fund. The advantage of this tactic is that when
you repurchase the shares you sold to offset the losses, you buy them at
a higher basis than they were before and thus you will incur a smaller taxable
gain when you later decide to sell. The major drawback of this approach,
as well as other sell/buy tax strategies, is that you incur transaction
* Minimize taxable gains
Of course, the best way to avoid needing to use taxable losses to offset
taxable gains is to minimize taxable gains in the first place. Possible
* Investing in individual stocks instead of mutual funds, because you can
better control the sale of individual issues.
* Using tax-efficient or index mutual funds. Remember, however, it's the
after-tax return that ultimately counts, so a poor-performing tax-efficient
fund isn't exactly a bargain. And watch out for buying high built-in gains
in these funds.
* Keeping income-generating investments, such as actively managed mutual
funds and higher-dividend stocks, inside tax-favored accounts. And keeping
growth stocks and index mutual funds in taxable accounts.
* Investing in tax-free municipal bonds. Again, it is the after-tax return
that ultimately counts. Sometimes you're better off buying taxable bonds
and paying the tax, than buying munis.
Zall, Bureaucratus columnist and a retired federal employee, is a freelance
writer based in Silver Spring, Md. He specializes in taxes, investing, business
and government workplace issues. He is a certified internal auditor and
a registered investment adviser. He can be reached at firstname.lastname@example.org.