On Capital Gains & Losses. Part I
Barrons was out last week with an article on the treatment of Capital Gains & Losses. I've excerpted it below as I think it is good introduction to a subject that I will deal in a serial format over the next week or so. The article below deals with the basic rules on Capital Losses. Warning. Post is longer than normal!
"IT'S AN ILL WIND, AS THE SAYING GOES, THAT BLOWS NO GOOD. Consider, for example, the capital-gains tax. While Congress agonizes over the rate of tax on net long-term gains, the question is largely academic -- because in the downturn, most of us have accumulated mountains of capital losses, and many years, if not a lifetime, of immunity to this tax.
The basic rule, under no apparent threat of change, is that you can deduct only $3,000 of net capital loss against your ordinary income on any year's return; any excess can be carried over onto your returns for the following years, subject to the same annual $3,000 limit, until the loss is exhausted.
The value of excess losses (those not immediately deductible against ordinary income) as a reserve against future taxes isn't always appreciated. "What good," a friend complained, "is $3,000 a year? I hope to pick up lots more gains once the market improves." She overlooked the potential of the entire backlog of losses as an offset to future capital gains.
Thus, suppose you incur $70,000 of net capital losses in 2009; after applying $3,000 against your ordinary income, you carry over $67,000. If you have a $40,000 net capital gain in 2010, it will be completely wiped out by $43,000 of the $67,000 you carried over from 2009, $3,000 of which will be applied against your 2010 ordinary income. That in turn will leave a $24,000 backlog ($67,000 less $43,000) loss to be carried over to 2011......"
Link: http://online.barrons.com/article/SB124303130732448469.html {Subscription may be required}
The Barrons piece above has given me an opening to extensively cover the issues of capital losses. Investors often have a very hard time with these and usually is becuase in their minds these losses aren't permanent until taken. The stark reality of cashing in, of seeing those negative signs permanently etched in a blotter thrusts the finality upon them. The same thing can happen with investment gains but research into investor psychology has shown that most investors feel the pain of losses more than the joy of gains.
"IT'S AN ILL WIND, AS THE SAYING GOES, THAT BLOWS NO GOOD. Consider, for example, the capital-gains tax. While Congress agonizes over the rate of tax on net long-term gains, the question is largely academic -- because in the downturn, most of us have accumulated mountains of capital losses, and many years, if not a lifetime, of immunity to this tax.
The basic rule, under no apparent threat of change, is that you can deduct only $3,000 of net capital loss against your ordinary income on any year's return; any excess can be carried over onto your returns for the following years, subject to the same annual $3,000 limit, until the loss is exhausted.
The value of excess losses (those not immediately deductible against ordinary income) as a reserve against future taxes isn't always appreciated. "What good," a friend complained, "is $3,000 a year? I hope to pick up lots more gains once the market improves." She overlooked the potential of the entire backlog of losses as an offset to future capital gains.
Thus, suppose you incur $70,000 of net capital losses in 2009; after applying $3,000 against your ordinary income, you carry over $67,000. If you have a $40,000 net capital gain in 2010, it will be completely wiped out by $43,000 of the $67,000 you carried over from 2009, $3,000 of which will be applied against your 2010 ordinary income. That in turn will leave a $24,000 backlog ($67,000 less $43,000) loss to be carried over to 2011......"
Link: http://online.barrons.com/article/SB124303130732448469.html {Subscription may be required}
The Barrons piece above has given me an opening to extensively cover the issues of capital losses. Investors often have a very hard time with these and usually is becuase in their minds these losses aren't permanent until taken. The stark reality of cashing in, of seeing those negative signs permanently etched in a blotter thrusts the finality upon them. The same thing can happen with investment gains but research into investor psychology has shown that most investors feel the pain of losses more than the joy of gains.
Most investors try to put off that pain as long as possible by either ignoring the losses or by holding onto investments with the hope that they ultimately will make back what they have lost. Certainly there are times to do this as there are also times to average down into positions. Many investors however think that the actual loss implications of a bad investment out weighs any sort of analysis as to the value of the actual stock they are holding. They often end up holding onto a bad investment longer than they might otherwise have done so and losing out on the opportunity to recoup some of that loss in an equity or ETF better suited to the current environment.
We will begin a series on dealing with capital losses in the coming days. The next piece in this series will be posted next week and will confront the stark reality of what has happened to portfolios since the late 1990's. We'll begin exploring why investors should not ignore this topic.
posted by CR English at 6:30 AM
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