Deducting Investment Losses Off Your Taxes

This topic seems well-timed. It's on when and how much you can deduct from investment losses on your taxes. The summary:

First, you can use your capital losses to soak up your capital gains, with no dollar limit. For example, suppose you sold a stock earlier this year for a $25,000 gain. Now you sell another stock for a $25,000 loss. Put those two together, and your loss erases your entire gain. Thus, you don't owe any capital-gains tax on that $25,000 gain.

Now suppose your capital losses are bigger than your gains, or that you have no gains at all. In that case, you can deduct as much as $3,000 of net capital losses (or as much as $1,500 if you're married and filing separately from your spouse) each year from your wages and other ordinary income. Additional amounts get carried over into future years.

I think I'll have amounts to carry over for a few years (if you need details on what I'm talking about, see my Wednesday post on selling my mutual funds.)

Comments

[Rick]

Me too. Unfortunately, I had WaMu stock, never thinking that the government would seize the company, particularly while the executives were on a plane. Currently my WaMu stock is trading at a 99.7% loss :-(

[Tom Keller]

Why the heck would you sell into a huge loss anyway??? You make your paper loss into a real loss. So, you get a tax break, but it still doesn't do anything to make up for the loss (if over 3000)

I just can't understand why anyone would be selling in such a down market, unless they desperately need the money --

Oh well, just creates a great buying opportunity for the rest of us.

[Daniel]

Does this provision include 401k and IRA losses?

[Santos]

Tom,

The reason for selling at a loss (at least the reason I have) is "loss harvesting". I bought shares on an international index fund at about $40 a piece. I sold them 35 days ago at about $30 a piece and kept the proceeds in cash. Today I am buying the shares at $27 (which means I am getting more shares than the ones I sold). The result: I get a yearly $3,000 deduction for the next 7-8 years and have more shares that I had when I started, ready for when the market comes back.

One caveat. It is important to make sure you have not purchased the same shares 31 days before or after the sale at a loss or the IRS "wash-rules" will apply (that is why I held the proceeds for 35 days). Go to the IRS website for the details on wash-rules.

[FinancialFellow]

Ouch on WaMu. I was convinced to buy a bit of GM stock. I did so at $6.20 - against my better judgement. Currently it's hovering around $4.00. It's a tough call. Every fiber in my body tells me that the company has no solid future and will likely go under. That said, I have infinite faith in the government's ability to do the wrong thing by deciding to "protect jobs" and continue to bail GM out.

[Miss M]

Hi Tom, I sold because I felt the particular sector (emerging markets) wasn't going to come back for a long time. I also have another emerging market fund, so it was a duplication. I admit I might not have done it if I didn't have the two free trades, they made it an easier decision.

[Mark]

Right now, there's no justification for selling ANY mutual fund. ALL sectors are well below fair value, hence it's a great time to buy NOW. As far as individual stocks go, unless you are a stock-picking professional it's not a good time to buy. Even those companies like GM are on shaky ground and don't know whether or not they will be around if they can't get access to credit.

My advice is not to try to time the market with stocks. Set your stop loss now, and IF they are triggered, reinvest the proceeds into large-cap index funds to bring down your overall cost basis for long-term investing. Pick some high dividend-yield large cap funds. The domestic market will come back faster than emerging markets, as global markets look to the US for stability and the eventual turnaround in the global economy. In about six months the market will be back at its highs, as it foresees growth 6-9 months down the road in 2010.

[FMF]

Mark --

Actually, there is:

http://www.freemoneyfinance.com/2008/11/why-i-sold-my-mutual-funds.html

Though I do agree with your thinking (that we need to stay invested in the market.)

[Kevin M]

Daniel - this isn't applicable to 401(k) or IRAs since those are tax-advantaged plans. There is only one provision I know of that lets you take a loss on an IRA - but it is taken on Schedule A as a miscellaneous deduction, and I can honestly say I have not seen it used in over 10 years of doing this for a living.

[Mark]

FMF: I still don't agree with your assessment about selling "loser" mutual funds to offset your capital gains. Mutual funds spread risk and return over many stocks and sectors. If you were to sell individual stocks that showed no sign of turnaround (bad management, poor business model, etc.) to offset capital gains, it would make sense. But mutual funds are almost always tied to performance of some index or sector.

You would have been better off keeping the underperforming mutual funds, selling the funds that had outperformed the market, and happily paid capital gains taxes on your profit.

Which brings me to another interesting topic. Why would anyone think that paying capital gains is a bad thing?? You are making money and paying 20% off the top to preserve the other 80% profit. Paying capital gains is a sign of successful investing, as is NOT selling mutual funds in a down market. You may cut capital gains in a single year by using your strategy, but you do so by sacrificing greater potential gains in the future if you had kept the extra funds and sold them at a profit. Unless you feel that the new fund or stock is the next big thing and you're just dying to find cash to buy more shares, I don't see a good enough reason to use your strategy.

[rwh]

My mistake. The 5% capital gains rate for the 15% income tax bracket ended with the 2007 tax year. In 2008 the capital gains rate is 0% for those filers.

[Barbara Baass]

If I already have a $26,000 carry over would it be wise for me to sell now and take another loss & then put the funds back in the original ones in 31 days?

[Bill]

My wife and I are retired Senior Citizens (80 years old). Our entire savings was invested in a qualified IRA of Mutual Funds. Suddenly we were losing $5-6,000 almost every day. It took me about 3 weeks to believe it was real, and going to keep on. I got out, put what was left (80%) in CD's at 4.4%. We were living on Social Security and monthly withdrawals from our IRAs - and still are. If I had left the money in those funds (as my "Financial Planner" and Fidelity advised me to do) it would now be down about 80%. So much for "buy and hold"!

I can't get a job and replace that lost money - it's gone.

Is there no tax credit or any help for this loss?

[Ann McDonald]

I see there is no answer yet to the letter from Barbara 12/02/08. I am in about the same position. Are there no answers to this question?

[FMF]

Ann --

I suggest you contact your tax preparer for specific advice.

[Conrad]

I purchased WAMU stocks in the mid-1980's and allowed my shares to accumulate. I signed up to re-invest my stocks dividends. My shareholdings got to over 1,000 shares (total of shares I held and in the reinvestment program). At over $40 per share I was sitting on over $40,000 investment. Then WAMU filed bankcruptcy under Chapter 11. I have 2008 gains from a different company's stocks. Can I offset these two? What documents do I need to support the losses? I still have statements from the company that managed my re-investment portfolio. I will appreciate any help.

[FMF]

Conrad --

I'll post your question in a week or so. Stay tuned.

[GEORGE]

WHEN MY MOTHER DIED IN 2008 I RECEIVED AN INHERTANCE. I LEFT THIS MONEY IN AN ACCOUNT WITH A INVESTMENT GROUP THAT MY MOTHER WAS USING. AFTER A HUGE LOSS AND A DISAGREEMENT WITH THIS COMPANY, I WITHDREW THIS MONEY IN 2009. A FEW WEEKS AGO I RECEIVED A $22,000 TAX BILL FROM
THE IRS. COULD THIS BE CORRECT? THE INVESTMENT GROUP
SAYS THE IRS OWES ME MONEY FROM MY LOSS. I ASKED THEM WHY DIDN'T THEY DEDUCT TAXES WHEN I CLOSED MY ACCOUNT, IF IT WAS INDEED TAXABLE OR ,AT LEAST, OFFER TO DO SO. IN ANOTHER ACCOUNT,I JUST CLOSED AN INHERITED IRA WITH THEM AND TAXES WERE DEDUCTED FROM THIS. WHAT GIVES? THE INVESTMENT GROUP SEEMS TO BE COVERING THEIR BUTT AND NOT GIVING ME ANY ANSWERS. WHAT DO TOU THINK?
THANK YOU VERY MUCH AND GOD BLESS.