With the continued weakness in global financial markets there is a good chance that even though the value of your portfolio has dropped, you still maybe able to profit. As the old saying goes, there are only two certainties in life: death and taxes. While no one can say they have solved the certainty of death, there are ways to make your portfolio more tax efficient, and thus help lower your tax bill.
When reviewing prospective client portfolios, especially in the current market environment, every now and then we come upon a stock that is trading at a lower price than it was acquired at. When I advise the client to sell the stock and at least use the loss to offset other gains that have been generated in the portfolio, I am often met with a firm NO! The client says that he believes that the stock will go back up and he wants top wait to sell it. The are two faults with this answer. First, the stock hasn’t been a stellar performer until this point, what is to make you think that it will start going up. Secondly, there may be another way to profit from the poorly performing stock.
Tax-Loss Selling
When one decides to sell the positions at a loss in the portfolio, the term used is tax-loss selling. It’s a process of selling securities at a loss to offset a capital-gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income-tax rates than long-term capital gains.
Though they may not realize it, for many investors, tax -loss selling may be the most important way to reduce your tax bill. If done correctly, it can save you money and help you diversify your portfolio in ways you may not have considered. For example, Let’s say you have a gain in Stock A and you decide to sell it. You will be taxed on that gain in full. But if you have a loss in Stock B and you actualize it by selling, you can use the amount of the loss and offset it against the gain, thus, drastically reducing your taxes owed. You wont be able to recover the whole loss you suffer but it certainly cushions the blow.
Why wait
It’s customary for both professional money managers and investment advisors to wait until the end of the year to start selling their losing stocks. But there are no hard and fast rules as to this. Personally, I like to take advantage of downturns in the market, like we have now, to review clients’ portfolio and advise on taking losses. Keep in mind one of the golden rules of investing, to ride your winners. Some of the most successful investment strategies call for investors to hold on to their good performing stocks and sell the laggards, because chances are there is a good reason that they are lagging. After what we have already mentioned, there is and added value of selling the laggards, you get to use those losses to offset the gains you may have. So not only do you make your portfolio current, by holding only the good positions, but you can benefit financially as well by realizing the losses.
Be Careful
There is a rule in the US, called the Wash-sale rule, where the IRS disallows a loss deduction from the sale of a security if a ‘substantially identical security’ was purchased within 30 days before or after the sale. Let’s say that you bought 100 shares of General Electric March 1st and then sold 100 shares of GE on March 15 at a loss, the loss deduction would not be allowed .The wash-sale rule is designed to prevent investors from making trades for the sole purpose of avoiding taxes.
Speak with The Professionals
It’s important to speak with your accountant before implementing this tax loss strategy. Many times your accountant will work closely with your investment advisor in order to best serve your needs. The accountant will also be knowledgeable about any local tax implications, and can help you plan accordingly.
July 30th, 2008 at 6:33 pm
this an informative article..congrats on teh new site