Use investment losses to cut your taxes

Sure, it’s been a miserable couple of years to be a stock investor.  Since the euphoric market highs of March 2000, the stock market has been subject to frequent, gut-wrenching declines, culminating in the sell-off that followed the tragic events of Sept. 11.  A long-term investor who is diversified and focused may feel the pain, but knows he shouldn’t make any hasty moves.  Selling only locks in a loss and may keep you out of the market just when it shoots up again, right? Generally that’s true, but there is a good reason to sell in some cases right now: the ability to take tax losses.  The government allows you to deduct capital losses on the sale of stocks, bonds, mutual funds and other investments. A $1,000 loss on an investment is worth $275 in federal tax savings from someone in the 27.5% tax bracket.  This applies only to taxable investments: you cannot deduct losses on investments held in tax-deferred retirement accounts.  If you have a regular investment account, losses can be valuable.  You can offset an unlimited amount of investment gain, plus you can also deduct up to $3,000 of losses against other ordinary income.  Any losses over these amounts can be saved and deducted in future years. For instance, let’s say you have a gain of $1,000 on a stock sale and a loss of $5,000 on another stock sale.  You can deduct $4,000 on your tax return ($1,000 against the gain and $3,000 against ordinary income) and save the remaining $1,000 loss to deduct next year. A long-term investor knows he should always stay invested and that market timing doesn’t work. How does this square with tax-loss selling?  On individual stocks you have a problem: If you sell a stock to realize a loss and buy it back within 31 days, you can’t declare the loss due to the “wash sale rule.” That means you can be out of the market for 30 days and miss an upswing. Mutual fund investors have it easier, especially those who invest in index funds: they can sell a fund on which there is a tax loss and immediately buy a similar fund.  That way they can have their cake and eat it too, because they stay fully invested while being able to realize a valuable tax loss. Consider someone who invested $10,000 in a Standard & Poor’s 500 Stocks Index fund on Jan. 1 and sold on Oct. 26. The investor then repurchases another company’s S&P index fund. He stays invested but gets to declare a loss of  $1,634, worth a federal tax savings of about $450 at the 27.5% tax bracket.