Tax Loss Harvesting For Dummies

11Sep08

Lets face it, the market sucks right now. Chances are some of your stocks/funds are doing really bad. It happens. You can either:

A. Wait and hold on for the ride

B. Sell at a loss (zomg!) and let Uncle Sam help you out

Today we will discuss option B, technically known as tax loss harvesting.

How it Works

  1. You invested $10,000 in fund A last year
  2. This year the market takes a 20% decline and you have $8,000 in fund A
  3. You sell fund A for $8,000 at a $2,000 loss
  4. You wait 31 days and buy back fund A
  5. When tax season rolls around, you claim the $2,000 loss. Lets assume you are in the 25% tax bracket. You will get $500 back on your return.
  6. You invest that $500 in fund A
  7. Sometime later (maybe next year) fund A picks back up and is worth $12,000.

Not only did you buy and hold but you got $500 out of it too. Let’s not debate the minutiae of tax, I understand there is a capital gains tax for selling your fund etc. the bottom line is you take advantage of your losses. It’s an alternative way of thinking (prevents you from being emotional with your investments) and an excellent strategy if you are buying into solid funds with good fundamentals.

The Caveat

You have to wait 31 days until you can buy back the fund or else it is considered a “wash-sale” and the IRS will get on your ass. There are certain strategies such as buying into a fund that is similar to the original if you can’t stand staying out of the market for a month and a day.

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