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Profit From Your Losses
By: Rick D. Foytek, CFAToward the end of the year, investors typically begin to size up the performance of their investments for the year. Our winning positions, both realized and unrealized make us feel like geniuses while our losers sit there and remind us that we can't be right all of the time. Attempting to take advantage of your losses may help you overcome them both psychologically and financially.
First let's cover the basics. Short-term capital gains and losses are incurred in a holding period of less than one year. Long-term gains and losses are incurred for those holding periods exceeding one year. Short-term gains are subject to the individual's ordinary income tax rates, up to a maximum of 35%. Long-term gains are taxed at a 15% maximum for taxpayers above the 15% income tax bracket. Long-term gains are taxed at a 5% maximum for those in the 10% and 15% tax brackets.
The IRS allows taxpayers to match all short-term gains and losses against each other. Long-term gains and losses are also matched against each other. Any overall short-term gain or loss is then netted against any long-term gain or loss. If the result is a negative amount, no capital gains taxes are due and losses can be used to offset ordinary income up to $3,000 in the current tax year. Additional losses may be carried forward to be used in future years.
One last important note is the wash sale. A wash sale occurs when a taxpayer sells an investment at a loss and either has acquired or acquires a substantially similar investment during a period beginning 30 days before the sale and ending 30 days after the sale through a purchase, taxable exchange or purchase of an option. If a wash sale occurs, no loss is recognized for tax purposes on the sale. The loss that would have been recognized is now just added to the cost basis of the newly acquired investment.
With these facts in mind, we can think of tax loss selling as the government's way of letting you turn lemons into lemonade. Tax-loss selling does not turn a loss into a gain, but it may put more post-tax dollars into your pocket. If you sell before the end of the year and turn paper losses into real losses, you reduce the taxes you owe on any profits you took during the year. Remember, this strategy is for taxable accounts only.
Psychologically, selling your losers to offset gains in your portfolio can help you to view the loss in a more positive light. Sell the loser and move on. Or, if you are really convinced the holding is not a long-term loser, and that you just experienced unfortunate timing, you can sell the holding under the wash rules and re-purchase it 31 days later. You will take the loss and re-establish your position. Alternatively, you could decide to purchase an investment with a similar strategy immediately after selling the original. This would allow you to maintain the same exposure and still realize the loss. Care must be exercised however, as the IRS requires that the investment not be substantially identical.
As always, you should discuss and coordinate tax-loss strategies with your financial and tax advisors.
Rick D. Foytek, CFA, is the Chief Investment Officer at Clayton & McKervey Financial Group, LLC. His office is located at 2000 Town Center, Suite 1825, Southfield, Michigan 48075. Ph: (248) 205-8511, e: richard.foytek@raymondjames.com
Visit our website at www.claytonmckerveyfinancial.com. Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC.
