Tax-loss strategies for those investment dogs

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

strategies include:

* 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 [email protected]


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