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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Good Summary. My post tomorrow is about this topic as I am clearing out some of my losers as well. I still own some ETFC, but may just get out of it and move on. I really think it won’t go down from here, but I also don’t think it is a big winner either.
Actually, the market is open on Monday as well.
-Grant
TheCornerOfficeBlog.com
Double: I respect your decision but I’m holding on since I think 2008 will be a good year for it.
Grant: You are totally correct! I just got the days mixed up. I will change that sentence
Need to also consider what marginal tax rate applies this year (ie total income) compared to likely income in future years. No point realising capital losses to minimise this years tax if you’re in relatively low tax bracket. In future years you may be realising gains when you’re earning a higher income, so any losses realised in those years would be more valuable.
Hi David,
Here’s wishing you a very Happy and Joyous New Year!
I personally feel it’s good that we are taxed on the net capital gains. This helps us to offset any gains against the loss. And, getting tax benefits over any loss in the sense that we can carry forward the loss to the future years is interesting!
besides, capital gains/loss, there are various other tax deductions/credits available. I’ve shared 34 such deductions/credits at http://www.mortgagefit.com/tax/34tips-deduction.html
Let me know your thoughts on them.
Regards,
Jessica