When is a loss actually a gain? When that loss becomes an opportunity to lower tax liability, of course. Now is a good time to begin your year-end tax planning and attempt to neutralize gains and losses by year end. As you do so, it might make sense to use any capital losses incurred in 2016 to offset capital gains that also occurred this year.
Use a loss constructively
A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. You can use capital losses to offset any capital gains you realize in that same tax year — even if one is short term and the other is long term.
When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately) and carry the remainder forward to future years until it’s used up.
Research and replace
Years ago, investors realized it could be beneficial to sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses when an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.
Waiting 30 days to repurchase a security you’ve sold might be fine in some situations. But there may be times when you’d rather not be forced to sit on the sidelines for a month.
Fortunately, there may be another alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Your solution is now simple and straightforward — you simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you’ve added to your portfolio a stock you believe has more potential — or less risk.
Gain an advantage
If you bought shares of a security at different times, give some thought to which lot can be sold most advantageously. The IRS allows investors to choose among several methods of designating lots when selling securities, and those methods sometimes produce radically different results.
If you’re buying mutual funds, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability. At the same time, bear in mind that prior dividends paid and reinvested in mutual funds you own were taxed, and therefore increase your tax basis in the fund.
End on a high note
Investing is always chancy, and capital losses incurred by selling stock for less than the original purchase price are nearly inevitable. But it’s important to remember that, in terms of tax planning, you can turn these losses into opportunities — and end the year on a high note.