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Taxing investment losses
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November 26, 2001: 11:37 a.m. ET
Can I carry over losses when getting the tax benefit?
MONEY columnist Walter Updegrave
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NEW YORK (CNN/Money) - I expect that my investment losses will outweigh my investment gains this year. Can I carry over losses to future years and, if so, for how long?
Before I get to your specific question, Jim, I'd like to outline the fundamentals of tax-loss selling for those who might not be familiar them. You see, with investors facing the back-to-back annual declines in the stock market for the first time since 1973-74, I suspect many of us are in the position of sitting on more investment losses than gains this year. And even those of us who haven't actually sold stocks or funds for a loss might want to consider doing so before the end of the year so we can book tax losses that can lower our tax bill come April.
The fundamentals
The basic premise behind selling a stock or fund for a tax loss is simple. Let's assume you have $5,000 in capital gains from stocks or funds you sold this year. Or, perhaps you received $5,000 in long-term capital gains distributions from funds you still own. If by the end of this year you've sold enough shares of stocks or funds that have gone down in value to create a $5,000 loss, that loss would wipe out your gain, as well as the taxes due on it.
So, for example, if your five-grand profit had been a long-term capital gain -- that is, one resulting from sales of shares held longer than a year and taxed at a maximum rate of 20 percent -- then creating a $5,000 loss could trim your tax tab by as much as $1,000. If, on the other hand, your $5,000 profit had been the result of a short-term capital gain -- one resulting from sales of shares held a year or less and taxed at ordinary income rates of as much as 39.1 percent this year -- then you could save as much as $1,955.
"Wash sale" rules and other exceptions
Of course, in this market it may very well be the case that you don't have enough gains to soak up those losses, which is Jim's problem. Not to worry. You can still lower your IRS bill by applying up to $3,000 in investment losses against ordinary income from sources such as wages, dividends and interest. If you still have losses left over after doing that, they can be carried over to future years until you've used them up.
If you believe an investment you've sold for tax purposes still has excellent potential, you can always buy it back. Just be sure you don't run afoul of the IRS's dread "wash sale" rules, which disallow all or part of your loss if you buy or sell the same security or a "substantially identical" security 30 days before or 30 days after the sale. If you don't want to wait that long for fear of missing a big gain in a stock, you can get around the wash sale prohibition by buying shares of a major company in the same business as the company you unloaded. In the case of mutual funds, you can simply buy another fund that invests in the same type of stocks as the fund you sold.
As with virtually all tax matters, tax-loss selling is subject to a slew of nitpicking rules and mind-numbing regulations. For more on how to salvage at least a bit of savings from stock losses, I suggest you check out IRS Publication 550. Cleverly titled "Investment Income and Expenses (Including Capital Gains and Losses)," this publication will tell you more than you ever wanted to know about deducting capital losses. 
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