Give Yourself A Holiday Tax Gift

For many, finding ways to save money — and even better, gain money — is vital in navigating an uncertain and scary economic environment. In planning for  year’s end, it’s not too late to trim your tax bill for 2008. Here’s what you can do now:

Gain from losses.
“Harvesting losses should be a routine part of year-end planning,” says Lee Baker, president at Apex Financial Services in Tucker, Georgia. “You should consider it for your holdings in non-qualified accounts.”

Non-qualified accounts are taxable accounts rather than tax-deferred retirement plans such as IRAs and 401(k)s. If your investments in taxable accounts are trading below the price you paid–many stocks and stock funds are way down this year–sell them before December 31.

“You can deduct 100% of capital losses against capital gains and $3,000 against ordinary income,” says Ivory Johnson, director of financial planning at the Scarborough Group, an investment advisory firm in Annapolis, Maryland. Thus, the losses you take can offset any gains you’ve taken in 2008, wiping out the tax you would have owed.

If your losses exceed your gains this year, up to $3,000 of net capital losses, can be deducted from your ordinary income on your 2008 tax return. If you are effectively in a 30% bracket (counting state and federal tax), you’ll save an easy $900 in tax: 30% times $3,000.

What if you wind up the year with, say, $10,000 in net losses? After deducting $3,000 of those losses, the excess $7,000 can be carried forward to future years, with no expiration date.

Those losses can offset the tax you’d otherwise owe on capital gains you take in 2009, say, or 2010. What’s more, each year you can deduct up to $3,000 of losses you have not yet been able to use.

Don’t plunge into wash sales.
If you want to reinvest the proceeds after taking capital losses, proceed cautiously.

Suppose, for example, you sell shares of ABC Corp. at a loss. However, you still think the company has promise, especially at today’s low price.

If you invest in ABC within 30 days, the IRS will call this a wash sale: you sold and bought, so nothing changed. You will not be allowed a capital loss on your tax return.

To avoid tax problems, you can sell ABC and park the proceeds in a money market fund for 31 days or longer. This strategy might be prudent in current market conditions.

“There’s an old saying that you never catch a falling knife,” Johnson says. “You should be careful about purchasing when the market drops as precipitously as it has recently. I haven’t invested new money for my clients in the past month or so.”

Baker agrees that it might make sense to keep the proceeds on the sidelines for a while. “Municipal money market funds have very attractive yields now,” he says, and the interest you earn will be tax-exempt.

If you’d prefer to reinvest right away, you can’t buy what you’ve sold at a loss or something