Investing 401

Developing a solid tax strategy is critical to making sure your profits don't turn into a loss

for signs of recovery before moving that money back into the market.

By taking a large paper loss on a stock or a mutual fund right away, an investor can build up a “bank” of tax losses that can be used to offset future gains. In that position, you can take capital gains without worrying about the tax bill.

“When clients have to decide what to sell, I recommend that they sell the losers and keep the winners,” says Femi Shote, a financial planner at Asset Harvest Group in Waltham, Massachusetts, who calls the process “harvesting assets.” As Shote puts it, “We have developed a strategy to help assure that assets are being harvested in the most effective manner. When done in a taxable account rather than in a tax-deferred retirement plan, this strategy provides immediate tax losses, while deferring taxable gains.”

Be mindful of the “wash sale” rules. If you sell a security at a loss, and then buy it back immediately, you can’t count the transaction as a capital loss. “You run into the wash sale rules,” says Daniels. “I tell clients they have to wait more than 30 days before they buy back the same stock or fund.”

An alternative is to buy a comparable security — one in the same sector or industry, but with better prospects for growth. For example, if you sell Ford (NYSE: F) stock at a loss, you might buy General Motors (NYSE: GM) right away without jeopardizing your tax break. “Similarly, you can sell a mutual fund that hasn’t done well and buy a similar one,” says Osmond Baptist, a financial planner at Members Financial Services in Atlanta. You might sell one growth fund at a loss, and immediately reinvest the proceeds in another better-performing growth fund.

DODGING DISTRIBUTIONS
Mutual fund distributions can provide you with unwelcome gains. If you invest outside of a retirement plan and put your money into mutual funds, you’ll owe taxes each year on earnings realized by the fund, even if you hold on to your fund shares and reinvest all distributions. “Therefore,” says Baptist, “if you’re going to sell a fund at a loss, sell before it makes a capital gains distribution. Similarly, try to avoid buying a fund right before a distribution, because you’ll get that distribution and owe taxes.” Most funds will tell callers when distributions can be expected.

Tax-managed mutual funds can provide shelter. Some funds intentionally avoid realizing gains, or offset any gains by taking losses. On Websites such as www.morn ingstar.com, you can find a number of mutual funds with the words “tax-managed” in their titles. “Funds that aren’t intentionally tax-managed may be tax-aware,” says Baptist. “To minimize taxes, look at a fund’s record for the past five years and invest in one that has made minimal distributions of capital gains.”

Variable life insurance can provide tax-free, not merely tax-deferred, investment income. Baptist sometimes suggests variable life insurance to selected clients. “There has to be a need for insurance,” he says. “If so, variable life can pay off

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