How To Offset Losses In The Financial Crisis

The Benefits Of Tax Loss Selling

“If you’re like most of us in this bear market,” writes Retirement Planning Guru Extraordinaire Paul Terhorst, 25 years retired overseas, “you have huge losses in at least parts of your portfolio right now. To generate capital losses for tax purposes you may want to sell those loss positions. Then buy back similar stuff right away. Do it now, in the 2008 tax year, if you can use the losses to offset taxable gains from earlier this year. Otherwise wait and do it in 2009.

“If you’re a long-term investor like I am, you’re reluctant to sell at a loss. You want to stay in the market to be in on the recovery. Once this market finds a bottom–as of this writing, we’re still waiting–stocks can pop up 30% or more in just a few weeks. IRS wash sale rules require that you wait 30 days before buying back into a position. Sell IBM at a loss in the morning and buy it back in the afternoon, or even the next week, the IRS considers the loss on sale never happened.

“However, you can buy back similar positions. For example, if you own a Vanguard index fund that’s under water, you can sell it and buy another Vanguard index fund, one that’s tied to a different index.

“You can take the opportunity to rebalance your portfolio. Sell out of U.S. stocks and buy into global stocks.

“You live overseas, or you are thinking about it, and maybe you need more exposure to overseas markets. The point is to stay in play, to have roughly the same amount at risk before and after the tax-loss selling. Remember that you can carry capital losses forward and use them to offset gains in future years.

“As it happens, we’re on top of a year-end 2008 close. That means you can choose whether to generate the losses this year or next. If you have gains to offset from earlier this year, take at least some losses now. Otherwise, wait until January.

“Waiting until January, of course, runs the risk that this market will pop back up, and you’ll have fewer losses. Then again, you’ll be so happy at the recovery you’ll forget about a tiny thing like tax losses.

“One additional wrinkle this time around: Obama has said he wants to raise capital gains taxes, maybe tax them at the same rates as ordinary income. If you think this is likely to happen, you may want to take most of your losses next year rather than in 2008. That way you’ll protect against an increase in capital gains taxes that much further out.

“As always check with your tax advisors–and your political advisors, if you have any–about the details of the tax rules and whether Obama will likely make good on his pledge to raise capital gains taxes.”

Kathleen Peddicord