For many people, thinking about taxes is always a last-minute
job. But even though millions of people still haven't finished
their tax returns from
last
year, now's a great time to start looking at a smart tax strategy
that could
cut thousands off your tax bill
next year. Even if you're an eternal procrastinator with your
taxes, getting the jump on the competition could make things much
better for you than waiting until the end of the year.
The strategy
With the stock market up for the year, few investors are thinking
much about
taking tax losses on losing positions
. But as the year progresses, you can expect other investors to
pay more and more attention to their underperforming stocks.
The reason is simple: The IRS lets you claim losses on your
investments against other income on your tax return, but only if
you actually
sell
those losing investments. Once you sell, you can offset the
resulting capital losses against any capital gains you have on
winning stocks that you've sold during the year. Moreover, even
if you use up all your capital gains, you can offset up to $3,000
more in capital losses against other types of income, including
wages or interest income. Taken together, using this tax-loss
harvesting strategy to offset income with losses can save you
thousands on your tax bill next April.
Why you should do it now and not later
As far as the IRS is concerned, it doesn't matter whether you
sell on Jan. 1 or Dec. 31. So long as you sell during the tax
year, you get to claim your tax loss in that tax year.
But because many people wait until the end of the year to
think about tax-loss harvesting, you'll often see an interesting
phenomenon develop. Often, stocks that have fallen during the
year will fall further in November and December, with one
possible explanation being that tax-loss sellers are bidding down
the stock, willing to sell at lower prices just to get a tax
break.
By mid-year, it's not too hard to identify which stocks are
going to be tax-loss targets come autumn. For instance, while
many technology stocks have done pretty well so far this year,
hardware specialists
Hewlett-Packard
(
HPQ
) and
Dell
(Nasdaq: DELL) are sitting on losses of 25% or more over the past
six months.
Weak PC sales
threaten their future prospects, especially considering that
neither has a strong entry in the mobile space to replace its PC
exposure.
International markets are also an obvious place to find
tax-loss candidates. In Europe,
Banco Santander
(
SAN
) and
Telefonica
(
TEF
) are
struggling with the Spanish descent
into the worst of the financial crisis, even though both
companies have extensive worldwide operations. But even some
once-promising emerging-market stocks have taken it on the chin,
with
Petroleo Brasileiro
(
PBR
) down more than a third in the past six months as oil prices
decline and gradual steps toward nationalization in nearby
Argentina raise doubts about South America's political
stability.
A bonus for acting early
Apart from getting a necessary job out of the way, one added
advantage of thinking about tax-loss selling early is that you
have more choices on what you want to do next. Once you sell a
stock at a loss, you can't buy it back until you've waited 30
days. Those who wait until December often get annoyed as a Santa
Claus rally, followed by the fabled January Effect, ends up
pushing shares much higher just after they've sold out.
But by selling early, you can buy back long before the year is
out, potentially even picking up bargains if later tax-sellers
cause prices to fall. Alternatively, if you think your stocks
will rebound, you can
buy
more shares and
then
wait 30 days, effectively doubling up your position for a month
but leaving you ready to sell your higher-basis shares with
plenty of time to spare.
Moreover, most mutual funds do their tax-loss selling early,
because their fiscal years end Oct. 31. You want to get in ahead
of the funds, as well as your fellow individual investors.
Start saving today
Sure, July might be early to think about taxes. But the
flexibility of the tax-loss harvesting strategy makes it worth
considering long before the ball drops on Times Square.
Of course, nobody wants to focus only on losers. Get some
winners in your portfolio by reading the Fool's special report:
"3 Stocks That Will Help You Retire Rich." Get your free copy
today while it lasts!
Tune in every Monday and Wednesday for Dan's columns on
retirement, investing, and personal finance. You can follow him
on Twitter
@DanCaplinger
.
Fool contributor Dan Caplinger knows it's never too early to
think about taxes. Motley Fool newsletter services have
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