NEW YORK (Tribune Media Services) - If the bear market has you thinking about selling some stock or mutual fund shares, there are tax issues to consider. Some simple strategies can minimize the capital gains tax bite on the sale of profitable investments and maximize the tax benefit for your investment losses.
Designating shares
If you plan to hedge your bets and cash in part of your holdings in a particular stock or mutual fund, think carefully about what instructions you give in your "sell order." Most people simply tell their broker or mutual fund how many shares they want to sell. But if your shares were purchased at different times and prices, you may find it pays to designate in your sell order which specific shares to sell.
For instance, you could minimize your taxable gain by instructing your broker or mutual fund to sell the shares you acquired at the highest prices. If you don't identify which specific shares are to be sold when you place your sell order, the IRS will make you use on your tax return a much less favorable method for determining which shares were deemed sold. When deciding which shares to designate in your sell order, the size of gain isn't the only factor to consider. You'll also need to take into account how long the shares have been held since much higher capital gains rates apply to shares held one year or less.
Donate shares
Another way to reduce the capital gains bite on stock market profits is to donate some of your stock or mutual fund shares to charity instead of selling them. If you're planning to make a sizable charitable donation in the near future anyway, you'll save more in taxes by donating the shares rather than writing the charity a check. So long as you've owned the shares more than one year, you'll be eligible to claim a charitable deduction for the current market value of your donated shares. In addition, you won't have to pay any capital gains tax on the appreciation.
When deciding which shares to donate, try to pick those shares that would save you the most in capital gains tax. For instance, if you're considering selling shares with gains of $20 and $30, donate the shares with the $30 gains. Be sure any shares you donate have been held more than one year. If you donate shares held one year or less, your charitable deduction will be limited to what you originally paid for the shares -- not their appreciated value. Don't donate shares that are selling for less than you paid for them. The only way you can claim a capital loss for those shares on your tax return is to sell them yourself. If you give the shares directly to charity, you won't be eligible to deduct the loss.
Investment losses
If you decide to bail out of a money-losing stock or mutual fund, the tax code can provide some salvation. Investment losses are deductible -- up to a limit. Capital losses can be used to offset any capital gains you have plus up to $3,000 of other income, such as salary from your job. So if you realize $6,000 in capital gains this year from the sale of stocks and other investments, you can write off up to $9,000 in losses on your 2002 return.
Any excess losses can be carried forward for use in a future year. Because so many investors have realized far more losses than they can write off this year, Republican leaders in the House of Representatives are considering introducing legislation next month to increase the amount of losses that can be deducted each year.
Excess losses
If your capital losses are expected to exceed your capital gains this year by more than $3,000 (or whatever higher limit that Congress might approve), consider whether any of your profitable investments are worth selling to take advantage of the extra losses. If you sell the profitable investments before year's end, the excess losses can be used to make those gains tax-free.
Wash-sale restriction
If you're bailing out of a stock or mutual fund in order to write off the losses, be aware that the tax law contains restrictions on how quickly you can reinvest in that same stock or mutual fund. Under what is known as the "wash-sale rule," the IRS won't permit you to deduct losses from the sale of a stock or mutual fund if you buy shares in the same stock or mutual fund within 30 days of the sale. The wash-sale rule is intended to prevent investors from selling shares just to write off the losses and then immediately buying replacement shares so that they'll be able to profit when prices rebound. Of course, one option is to sell the shares and then wait the 30 days before reinvesting in the stock.
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The risk to waiting is that the stock will rebound within the 30-day period. Another option is to immediately reinvest your money in a similar stock or mutual fund. You can avoid the 30-day wash-sale restriction so long as you're investing in a security that isn't "substantially identical" to the one being sold. So if you're selling shares of a computer company at a loss but you're bullish on the industry, you could immediately invest in another computer company's stock without violating the wash-sale restriction.
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