Financial planning Harvesting security losses could lower income taxes

Sell securities with losses and the government will share your pain.
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Losses realized on investment asset sales offset gains realized on investment asset sales and mutual fund long-term capital gains distributions.

Losses in excess of net security gains can be deducted up to $3,000 against other income. Any excess loss is carried to future years.

Tax savings could be as much as 35 percent federal and, for a Colorado resident, 4.63 percent state.

Most Coloradoan readers are not in the 35 percent federal tax bracket (over $357,750 of taxable income for a married couple filing jointly). But many are in the 28 or 33 percent federal tax brackets (over $131,450 and $200,300 of taxable income for the 28 percent and 33 percent tax brackets respectively on a joint return).

A Colorado couple in the 28 percent bracket who realize a $10,000 net capital loss on securities held less than a year and sold may reduce their income tax $3,263.
If the loss is on securities held a year or longer, the federal tax savings is only 15 percent.

Taxpayers with unrealized security losses frequently make the mistake of not selling until the security returns to its purchase price.

The decision to realize a loss or not realize a loss should be made based on the prospects for the investment and not its purchase price. A rule of thumb is don’t sell if you would buy more of the security at its current price. If you would not buy more at the current price — sell.

What if the loss security is a mutual fund that has performed well long-term but has been hammered in the current market?

You can sell the security, realize the loss, wait 31 days, and buy it back.
Or you can buy additional shares 31 days or more before selling the shares you hold.

Either method will avoid the wash sale rule, which prohibits a tax loss on substantially identical securities bought or sold within 31 days on either side of the sale date.

You also could buy a similar but not identical security and avoid the wash sale rule. Suppose you own an S&P 500 index mutual fund on which you have a paper loss.

You could sell it and use the proceeds to buy an S&P 500 exchange-traded fund (ETF). Not all tax practitioners may agree with me but I would argue that even though you would be purchasing essentially the same basket of stocks there is enough difference between the two securities that they are not substantially identical.

Be careful if you are in the 10 or 15 percent tax bracket. Taxpayers in the 10 or 15 percent bracket have a zero tax rate on long-term capital gains and dividends on capital assets owned a year or longer. For 2008, the 25 percent bracket begins at $65,100 of taxable income on a joint return.

It may be worth the fee to consult a tax professional to help you plan to be in the 10 or 15 percent federal tax bracket.

http://www.coloradoan.com/article/20081109/COLUMNISTS20/81107011/

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Financial planning Harvesting security losses could lower income taxes