Capital Losses

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

At Cook & Co. we have developed a Systematic Loss Recovery Plan, SLRP (pronounced slurp), that will help many of our clients recover from stock market losses using the tax laws to their advantage!
 
Knowing when to book a tax loss and how much tax loss to book can make a huge difference! Avoiding the "Wash Sale Rules" is also extremely important! If you are emotionally attached to a stock and absolutely cannot bring yourself to part with it, there is a way you can book the tax loss and retain your stock with minimum risk (see below)!

There are several tax-advantaged strategies we may consider during our evaluation:
Consider taking losses that can save you taxes this year. In some cases, you may have losses that can be carried forward to offset gains in future tax years.

Consider a “stock swap.” Replace your existing holdings with similar companies in the same sector that offer a better potential return. You may potentially be able to switch to high-quality industry leaders.

Consider “doubling-up”. If you want to maintain a position in your portfolio, you can purchase a similar block of shares and wait 31 days to sell the original shares at a loss to recognize the unrealized loss in that position. This way, you will not lose potential appreciation that could occur while you are waiting for the “wash sale” period to lapse.

If you have mutual fund losses - Consider an exchange into another fund in the same family of funds. If you have bond losses - Consider a “bond swap.” In some instances, you will be able to maintain the current stream of income from your investments by extending the maturity date to another bond with a similar rating.

Generally, realized capital losses are first offset against realized capital gains. Any excess losses can be deducted against ordinary income up to $3,000 ($1,500 if married filing separately) on line 13 of Form 1040.

Losses in excess of this limit can be carried forward to later years to reduce capital gains or ordinary income until the balance of these losses is used up.

Capital gains and losses on the sale or trade of investments are classified as either short-term – if the property has been held for one year or less – or long-term on Schedule D of Form 1040. Though these two categories of capital gains and losses are subject to different rates in the event of a net gain, a net capital loss resulting from either category is directly deductible from ordinary income up to the annual limit.

This provision often works to the taxpayer’s advantage, yielding greater relief for losses than if an applicable long-term capital gains tax rate were used. Generally, capital gains rates are lower than the rates on ordinary income.

For example, if a taxpayer in the 25-percent bracket had a net long-term capital gain on stocks of $2,000, the tax due from the gain would be calculated at the 15-percent capital gains rate for a total of $300.

But if the same taxpayer has a net long-term capital loss of $2,000, the corresponding tax savings would be calculated at the individual’s ordinary rate of 25 percent, for a $500 reduction in taxes.

A "paper loss" – a drop in an investment’s value below its purchase price – does not qualify for this deduction. The loss must be realized through the asset’s sale or exchange.