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The plus side of investment losses

Posted by Cheryl Costa  September 12, 2008 10:28 AM

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The market has been very volatile lately and most long term investors are experiencing a "negative" 2008. The Standard & Poor's 500 Index is down approximately 15 percent year-to-date and the financial news seems pretty dismal at times. However, there is one bright spot -- tax loss harvesting opportunities are plentiful.

Basically, if you sell individual stocks or mutual funds for less than you paid for them, you will recognize a loss and you can subtract the loss from gains you might have somewhere else in your portfolio. If you don't have any other gains, the losses are still valuable because they can be used to offset up to $3,000 in ordinary income and the balance can be carried over to future years. (It might seem obvious, but we are talking about gains and losses in your taxable accounts, not your IRAs.)

As with most things in life, there is one "catch" and that catch is known as the wash sale rule. Under the wash sale rule, the IRS will deny your tax break if you have purchased the same (or a substantially identical) security in the 30 calendar days before or after the sale. The rules on what constitutes a substantially identical security are not always very clear, so if you want to make a "replacement" purchase within 30 days, it is probably best to consult your tax advisor or financial advisor. Also, it is important to note that if you do have a wash sale, the disallowed loss is not lost forever. Instead, your disallowed loss is added to the basis of the replacement security.

Tax loss harvesting really can be well worth your effort. If you are in the 33 percent tax bracket and you have a $3,000 loss that you can use to reduce your ordinary income, you will save almost $1,000 in taxes. However, there is a popular saying in our field: "don't let the tax tail wag the dog." In simple terms, this means that you shouldn't go crazy selling investments simply to capture a loss. A buy and hold strategy is still the best for most investors. You should simply be aware that if you find yourself holding an investment that no longer has a place in your portfolio, there may be some tax advantages to selling it.


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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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