Make The
Most Of Your Losses
By Vita Nelson, editor
The Moneypaper
After
a third wretched year on Wall Street, you may be sitting with
plenty of choices for tax loss sales. Although losses can be
taken until year-end, one particular strategy demands action
in November. To understand why you might want to act this month,
you should know the basic rules of capital losses. The tax code
permits up to $3,000 worth of net capital losses to be deducted
against ordinary income each year. Unused losses can be carried
forward indefinitely, deductible at $3,000 per year.
Should you take losses
in excess of $3,000? The answer, probably, is "yes."
Such losses can be used to offset taxable gains from other activities.
Also, when the stock market recovers, you'll be able to take
gains more freely, if you have a "bank" of unused losses
to net against those gains.
One reason you may
not want to take a loss is the risk that the stock will suddenly
start to perform as desired. You have to sell to take the loss.
But, if a stock was attractive enough to buy at, say, $50 a share,
then it may be an even better buy at $30. Once you sell, you
can't immediately repurchase the same stock or fund. Such a move
would violate the "wash sale" rules and prevent you
from claiming the capital loss.
How can you avoid the
wash-sale rules? One way is to sell the security and hold the
sales proceeds for 31 days. Then you can buy back the stock or
fund. However, with this method you run the risk that the stock
will shoot up while you are waiting on the sidelines.
Another approach is
to "double up." Before you sell a stock at a loss,
buy an equivalent amount of that stock. After 31 days, sell the
original lot at a capital loss. Say you hold 100 shares of Microsoft
that are worth less than you paid. You can buy another 100 shares
at the depressed prices. Thirty-one days from now, you can sell
your first 100 shares and claim the tax loss. You're still holding
your second 100 shares, so you won't miss out if the stock goes
up. Of course, this strategy assumes that you have sufficient
cash to buy the additional shares. It also requires that you
act no later than November 29 this year, so you can wait 31 days,
sell your original shares, and take a capital loss for 2002.
A third way to get
a capital loss and avoid the wash-sale rules is to buy a proxy
for the security that's been sold. You can buy a similar, but
not identical, stock in an attempt at minimal portfolio impact.
After 31 days, you can go back to your original holding if you
wish.
Investors who invest
in mutual funds can sell one large-cap growth fund and buy another.
Check the holdings to find ones that are holding similar companies.
We've been told that there is some controversy about whether
or not you can take a tax loss by going from one fund that tracks
an index into another fund that tracks that same index. We find
that surprising as each fund would have a unique symbol and would
be run by different management. But if you are concerned, you
could buy into another index that's closely correlated: for instance,
you might sell an S&P 500 fund and buy an S&P 100 fund.
Or buy our MP 63 Fund. It tracks our own DRIP Index and is certainly
unique and relatively successful, compared with most growth funds.
Check it out at Bloomberg.com/money. Our symbol is DRIPX. (And
we still have five stars from Morningstar!)
If you are planning to sell shares held in a DRIP, you will have to do a little extra planning. Once you've decided what stock(s) to sell, you need to consider how to do it, and whether to sell all of your DRIP shares or a specific number. (Think about keeping at lest one share in the account so that it remains active.) Most plans give you the choice of selling through the plan or withdrawing shares (in the form of a certificate) so that you can sell them elsewhere.
There are pros and cons to each method. The certificate method may take more time, since you have to request a certificate and, once it is received, deposit it into a brokerage account for sale (you may want to ask the transfer agent if an electronic transfer to your brokerage account is possible). The advantage is that you can determine the price at which to sell your shares, and choose the day of execution. Since it may take a few weeks for the transfer agent to send you the certificate, you'll want to initiate the withdrawal as soon as possible. Take care to check the correct box on the statement (usually located on the reverse side). If you plan to keep the account active, don't indicate "terminate."
Once you have received a certificate, it's a good idea to send it to your broker via certified or registered mail. Even if you're using an online broker, it may also take a day or two for the shares to be available for sale, since the broker is re-registering the shares in "street name" in your account. Although we don't encourage using online brokers from a trading standpoint, having such an account is a good way to dispose of certificate shares, either for year-end purposes, or if you've simply decided to exit a DRIP that has become investor-unfriendly. The ability to set a "limit" price for your sale is a plus, but you may have to simply sell "at market" if time is running short.
The other method of selling is certainly easier, but you have no control over the sale price, and sometimes the execution won't take place for a couple of weeks. Check the Guide to Direct Investment Plans for selling practices of the companies. Many plans now allow you to request a sale by phone, fax, the Internet, or by a mail request, and quick sales executions are becoming more common among "modern" direct investment plans. So be aware of which methods are allowed, and how quickly the sale is likely to occur. If you intend to mail the request, allow at least two weeks for the sale to take place. Note that a DRIP will not confirm your specific identification of which shares to sell. You should mark the shares you are selling in your own records and keep track of your remaining basis.
Once you've completed your sale, you may want to set aside a portion of the proceeds incase you need to pay additional taxes. If you've kept a DRIP open by selling less than all of your shares, wait for 31 days after the sale date before resuming your investments in that company, in order to avoid the wash-sale rule.
If you want to hold onto the shares in your DRIP and still take the loss, buy shares of the company in November, either through the plan or through a broker to follow the "double-up" strategy described above. It's probably best not to try to time the market. If you have a loss and you want to take it, just take it. You can't know in which direction the market will move.
Editor's Note: Vita Nelson is editor of The Moneypaper, 555 Theodore Fremd Ave., Suite B-103, Rye, NY 10580, 1 year, 12 issues, $99. The Moneypaper keeps readers abreast of timely financial planning and investment strategies. The Moneypaper's unique Direct Stock Purchase Plan allows subscribers to buy the one share of stock required to qualify for the Dividend Reinvestment Plans of 1,300 companies that sell their shares to the public directly. "You'll never pay another dime in brokerage fees or commissions," says Nelson. The Moneypaper is offering a Special Introductory Subscription Offer of 4 issues for $15. Visit www.moneypaper.com.
