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Today and tomorrow Next Monday is the last day to sell losing investments because you can deduct taxes from it. In the US, we are taxed on net capital gains for the year, which means that we should sell stocks that we have a capital lost in to offset all the capital gains, minimizing taxes. The government encourages this in fact, because not only can we balance it just right so we don’t pay ANY taxes for stocks we made money on, we can even get tax credit for a realized capital loss! Let me illustrate in the following example of what I mean.

Say in 2007, I bought $7,000 worth of Diamond Offshore (DO) and $15,000 worth of ETrade (ETFC). Now, DO is worth $15,000 so I decided to sell it, making $8,000 on the investment. However, ETFC is only worth $3,000. If I don’t sell ETrade, it means that I will have to pay taxes on the $8,000 investment. However, if I sell all my shares of ETrade, I would’ve realized $12,000 of capital lost. The net effect of both my investments will mean that I have a total capital loss of $-4,000.

What does having a capital loss mean? It means that not only do I not have to pay taxes for my $8,000 gain, I can use the difference in reducing my 2007 income and lowering my taxes. One catch is that we are only allowed to deduct $3,000 each year from other sources of income. However, I can carry the extra $1,000 forward to reduce my capital gains next year. If I get another bad year and more capital losses to report, I can carry the $1,000 forward indefinitely until I finally make money on my investments!

One important point is that we can only report capital losses that are realized. This means that the stocks must be sold before we can claim that we lost money in the investment. To avoid people selling losing stocks and buying them back immediately just for tax purposes, there is something called the wash sale rule. If you are wondering what this is, then come again for tomorrow’s article where I will talk more about it.

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