Make Lemonade From Lemons

Turn your investment losses into a sweet tax-time advantage

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0313_investing1Don’t feel too bad if your basket of stocks and mutual funds turned sour last year. The average stock fund lost nearly 40% in 2008. The favorite stocks of mutual fund managers, such as ExxonMobil, GE, and Microsoft, all suffered double-digit losses. One way to get over those losses is to turn them into tax time winners.

Suppose you bought 400 shares of Microsoft in 2007 at $35 a share. In 2009, you might sell those shares for $20 apiece. If so, you’d have a $6,000 capital loss, since you bought for $14,000 and sold for $8,000. By going through your stocks and funds held in taxable accounts and culling the losing culprits, you could wind up with $10,000 to $20,000 or more in total capital losses.

What good will that do? Those losses can offset any capital gains you realize later this year, making them tax-free. Without offsetting losses, you’d owe the IRS 15% on your realized gains.
“Even in a bad year, mutual funds might make capital gains distributions, which can be taxable to shareholders,” says Norman Graves, CPA, partner in the Washington, D.C., accounting firm Bert Smith & Co. “Capital losses can offset those taxable gains.”

There are two ways that capital losses can diminish your tax bill. First, they can reduce the tax you otherwise owe on capital gains. Second, if you have losses in excess of your gains, you can deduct up to $3,000 ($1,500 if married, filing separately) from other income.

According to Graves, “that deduction can be taken on the front page of your tax return,” he says. Such a deduction lowers your adjusted gross income (AGI). A lower AGI not only lessens your tax bill, it also may increase the other tax credits and deductions you can take. Any net losses you can’t deduct on your 2009 tax return may be carried over to future years. They can offset an unlimited amount of gains and also provide $3,000 annual deductions until the losses are used up.

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