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Take your (capital loss) medicine!

December 30, 2008

If there is a silver lining to this year's cloudy stock market, it's that capital gains taxes will be optional for many of us this year. How can a capital gain tax be optional? You are likely to have capital losses available in your portfolio that you can use to offset your gains. Now's not the time to be proud. Take your medicine by selling enough losers to offset your taxable capital gains, if you can.

Ah, you ask, but why would I have capital gains this year?

- First, the market didn't tank until well into the year. It's entirely possible that you sold stock at a gain before everything went south.

- If you own mutual fund shares, it's likely that they had to liquidate old positions to redeem panicky owners, incurring capital gains on ancient positions that they had to distribute to you. Your mutual fund company website probably can tell you how much that will be for 2008.

- Maybe you sold a business, or some other non-traded asset.

So how do you take your losses? If you own publicly-traded securities, and they're not from short sales (not bloody likely this year), all you have to do is sell them today or tomorrow; the tax law considers the trade date to be the date of the sale, even if the settlement occurs in 2009.

Mind the "Wash Sale" rules. If you bought other shares of the stocks you are selling today or tomorrow in the 30 days preceding the sale, or if you buy back the stock in the 30 days after the sale, your loss is disallowed - even if the purchases are in an IRA.

Remember, you only get to deduct losses in a taxable account. Sales in an IRA or a 401(k) don't offset capital gains on your 1040. And you can only deduct capital losses to the extent of your capital gains, plus $3,000, so you don't need to overdo it. If you do take more losses than you need, capital losses carry over indefinitely until you use them all at the rate of $3,000 per year, or until you incur enough capital gains to absorb them.

Tune in tomorrow for the final installment of our 2008 year-end tax planning series.

Flickr image from Aussiegall

Tags: year-end tax planning.