As investors wrestle with their 2001 tax returns, they’ll quickly discover that the odds are stacked in favor of the IRS. Investment gains are fully taxable, while investment losses are deductible only in part: perhaps a small part. Heads the IRS wins, tails you lose.
Fortunately, you don’t have to meekly accept this fate. “If you know the rules and you have the right tax strategies, you can offset investment gains with losses and come out ahead,” says Mario J. Daniels I, a CPA at Mario J. Daniels & Associates in Flint, Michigan.
Maximizing the profit from winning investments and minimizing the sting of losing stock picks are the keys to maintaining a profitable portfolio. Parts one, two and three of our series on investing were intended to help sharpen your ability to pick winning investments. This final part of the series will help your efforts really pay off. It’s what you keep after the investment is sold that ultimately makes the difference. Here are some rules you should know:
Long-term gains are better than short-term gains. If you sell a stock or mutual fund you’ve held for 12 months or less, any profit will be taxed at your regular tax rate. In 2002, the top federal tax rate is 38.6%. If you hold on to a stock that has increased in value for more than a year before selling, you automatically lower your tax bill. After a year, “any profit will be a long-term capital gain and federal tax will be no more than 20%,” says Daniels.
Use trading losses to offset trading gains. One of Daniels’ clients is Rob Boyler, president and CEO of International Financial Corp., a Flint company that provides financing for mortgages and capital equipment. “During the bull market,” he recalls, “I made some profits on Internet stocks. When I took those profits, I had short-term gains, which would have been highly taxed.”
Therefore, Boyler sold some other stocks at a loss. “In fact,” says Daniels, “he took losses that exceeded his gains by $10,000 early last year. That gave him a $3,000 tax loss for the year and a $7,000 capital loss to carry forward, as well as cash in his pocket from selling those stocks.”
Under the tax law, your capital gains and capital losses are netted each year. Net capital gains are fully taxable, short- or long-term. If you have a net capital loss, up to $3,000 per year can be used as a tax deduction from your ordinary income. Any capital losses beyond $3,000 can be retained for the future, when they can offset net gains.
Harvesting losses can pay off. Some investors match gains and losses at year-end, in an effort to wind up the year with net losses rather than net gains. However, taking losses can be a year-round strategy. “I sold some stocks at a loss during 2001, well before the end of the year,” says Dr. Thermutus McKenzie, a physician at Comprehensive Women’s Healthcare in Atlanta. McKenzie says that she has been waiting