Don’t feel too bad if your basket of stocks and mutual funds turned sour last year. The average stock fund lost nearly 40% in 2008. The favorite stocks of mutual fund managers, such as ExxonMobil, GE, and Microsoft, all suffered double-digit losses. One way to get over those losses is to turn them into tax time winners.
Suppose you bought 400 shares of Microsoft in 2007 at $35 a share. In 2009, you might sell those shares for $20 apiece. If so, you’d have a $6,000 capital loss, since you bought for $14,000 and sold for $8,000. By going through your stocks and funds held in taxable accounts and culling the losing culprits, you could wind up with $10,000 to $20,000 or more in total capital losses.
What good will that do? Those losses can offset any capital gains you realize later this year, making them tax-free. Without offsetting losses, you’d owe the IRS 15% on your realized gains.
“Even in a bad year, mutual funds might make capital gains distributions, which can be taxable to shareholders,†says Norman Graves, CPA, partner in the Washington, D.C., accounting firm Bert Smith & Co. “Capital losses can offset those taxable gains.â€
There are two ways that capital losses can diminish your tax bill. First, they can reduce the tax you otherwise owe on capital gains. Second, if you have losses in excess of your gains, you can deduct up to $3,000 ($1,500 if married, filing separately) from other income.
According to Graves, “that deduction can be taken on the front page of your tax return,†he says. Such a deduction lowers your adjusted gross income (AGI). A lower AGI not only lessens your tax bill, it also may increase the other tax credits and deductions you can take. Any net losses you can’t deduct on your 2009 tax return may be carried over to future years. They can offset an unlimited amount of gains and also provide $3,000 annual deductions until the losses are used up.
Suppose John Smith has
$20,000 of capital losses in 2009 and no capital gains. He’d take a $3,000 deduction this year and carry over the other $17,000. Say John has $10,000 in net gains in 2010. He’d use his old losses as an offset, so those gains would be tax-free. He can deduct another $3,000 of old losses in 2010. After using up $13,000 of his $17,000 in losses in 2010 ($10,000 to offset gains and a $3,000 deduction), John will still have $4,000 of his old losses to use in future years.Before you get too excited, listen to the catch: Say you sold Microsoft stock at a loss, but you now think Microsoft is a good buy. If you repurchase the software giant’s shares within 30 days of the sale, your capital loss won’t count. After taking a capital loss, therefore, you should wait at least 31 days before buying back the stock or fund you sold. If you don’t want to be out of the market that long, you can reinvest right away as long as you don’t buy a fund that has virtually the same holdings as the one you sold at a loss. Employing these strategies should soothe some of the pain from 2008’s market losses for years to come.
This story originally appeared in the April 2009 issue of Black Enterprise magazine.