Plan Ahead for Year-End Tax Selling

November 2007

Considering how volatile the market has been recently, you may own stocks or stock funds trading at a loss. If so, realizing those losses before year-end can provide valuable tax advantages.

Realized capital losses can offset realized capital gains for 2007. Net capital losses can be deducted, up to $3,000 per year, against ordinary income. In addition, any net losses you can't deduct can be carried forward indefinitely to offset capital gains and provide more deductions in future years.

Watch out for wash sales
You must follow certain rules to get the tax advantages of a realized capital loss. For starters, losses you take in a tax deferred or tax-free account won't generate any tax benefit.

You can get tax benefits if you take a loss in a taxable account. However, you can't count the loss if you enter into a "wash sale." A wash sale occurs if you buy the same security you've sold within 30 days of that sale. You count the 30 days before and the 30 days after the sale that generates a loss.

Doubling up
One way to avoid a wash sale is to buy the security at least 31 days before you sell it. You must initiate this strategy before the end of November if you plan on a tax loss in 2007.

Suppose, for example, you own 100 shares of a mortgage real estate investment trust (REIT) that has tumbled in price as a result of concerns over sub-prime loans. You think the market has overreacted and you expect the price to rebound sharply, perhaps in the next few weeks. You could buy another 100 shares of the same mortgage REIT. Thirty-one (or more) days later, you can sell the 100 shares you originally owned.

If the original shares are still trading at a loss, you will have a valid capital loss. You'll also own 100 shares of that mortgage REIT, from your double-up purchase, and you will not have been on the sidelines.

As you can see, you must buy the duplicate lot in November. That will enable you to sell the original lot in late December and sustain a capital loss this year.

Other tactics
There are other tactics you can use to avoid a wash sale. One approach is to simply take a loss and park the money in cash for more than 30 days. Then you can buy any security you'd like.

Another method is to immediately buy a similar but not identical investment. You might sell one mortgage RET and buy a different mortgage REIT. That won't be a wash sale, and you'll be in position to benefit from any resurgence in that market sector.

(Reprinted from the November 2007 CPA Client Bulletin; a monthly publication of the AICPA)

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