On Capital Gains & Losses Part VI Basic Tax Rules.
In this installment on Capital Gains & Losses were going to lay out the basics of the main parts of the tax code that deals with Capital Losses. Please note that this is not an exhaustive review of the tax code. It is just an overview. Also since I am not an accountant you MUST discuss any of these strategies with your own financial planner or tax advisor if you are not a client of our firm. Also Please note this is a brief review of how the tax rules currently work. At this time there does not seem to be any legislation moving through Congress that would change this part of the tax code. However that is not to say that these laws might never change. Certainly with the amount of money need by all governments it is a distinct possibility that these laws at some point could be revised or changed.
The first excerpt takes us back to the original article from Barrons which laid out the basic tax loss rules. {Rules highlighted in Green.}
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}
Here from Smart Money is an explanation of the Wash Sale Rule:
THE SAVING GRACE of making a poor stock or mutual fund investment is that you at least get a capital loss when you sell. The loss can then offset gains from your more successful investments, unless the dreaded wash sale rules disallow your writeoff. Here's the scoop on this nasty little piece of the tax code.
The Skinny on Wash Sales. Your anticipated tax loss is disallowed if, within the period beginning 30 days before the date of the loss sale and ending 30 days after that date, you acquire "substantially identical" stocks or securities. For purposes of this article, let's call them replacement securities.
According to the tax law, your loss transaction and the purchase of the replacement securities are a "wash," so you shouldn't be allowed any tax benefits. Please understand, however, that this righteous concept applies only to losses. If you sell for a gain and buy back identical stocks or securities within the above time frame, Uncle Sam is happy to collect his due with no qualms. (Among us tax professionals, this is known as a "heads I win; tails you lose" rule.)
Options are included in the definition of stocks and securities, so you can also have a wash sale when you unload options at a loss.
But for the wash sale rules to come into play, the stocks or securities must truly be substantially identical. Stocks or securities issued by one corporation are not considered substantially identical to stocks or securities of another.
What about replacing one S&P 500 index mutual fund with another? Unfortunately, the IRS begs the question by saying only that all circumstances must be considered in evaluating whether stocks or securities are substantially identical. What the heck does that mean? Nobody knows. In my opinion, no mutual fund is substantially identical to another. That said, you should be wary of selling, for example, one S&P Index fund for a loss and then buying into another S&P 500 index fund within 30 days.
Also, don't think you can have your spouse buy identical replacement securities without running afoul of the wash sale rules. Your tax loss is still disallowed. Ditto if your controlled corporation or IRA makes the buy, according to the IRS.
What Happens to Your Loss? The only good news about wash sales is that your disallowed loss doesn't just go up in smoke. Instead, it gets added to the basis of the replacement securities. When you sell them, your disallowed loss effectively reduces your gain or increases your loss on that transaction. Also, the holding period of the wash sale securities is added to the holding period of the replacement securities, which increases your odds of qualifying for the favorable 15% rate on long-term capital gains.
Link: http://www.smartmoney.com/personal-finance/taxes/understanding-the-wash-sale-rules-9860/?hpadref=1
The first excerpt takes us back to the original article from Barrons which laid out the basic tax loss rules. {Rules highlighted in Green.}
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}
Here from Smart Money is an explanation of the Wash Sale Rule:
THE SAVING GRACE of making a poor stock or mutual fund investment is that you at least get a capital loss when you sell. The loss can then offset gains from your more successful investments, unless the dreaded wash sale rules disallow your writeoff. Here's the scoop on this nasty little piece of the tax code.
The Skinny on Wash Sales. Your anticipated tax loss is disallowed if, within the period beginning 30 days before the date of the loss sale and ending 30 days after that date, you acquire "substantially identical" stocks or securities. For purposes of this article, let's call them replacement securities.
According to the tax law, your loss transaction and the purchase of the replacement securities are a "wash," so you shouldn't be allowed any tax benefits. Please understand, however, that this righteous concept applies only to losses. If you sell for a gain and buy back identical stocks or securities within the above time frame, Uncle Sam is happy to collect his due with no qualms. (Among us tax professionals, this is known as a "heads I win; tails you lose" rule.)
Options are included in the definition of stocks and securities, so you can also have a wash sale when you unload options at a loss.
But for the wash sale rules to come into play, the stocks or securities must truly be substantially identical. Stocks or securities issued by one corporation are not considered substantially identical to stocks or securities of another.
What about replacing one S&P 500 index mutual fund with another? Unfortunately, the IRS begs the question by saying only that all circumstances must be considered in evaluating whether stocks or securities are substantially identical. What the heck does that mean? Nobody knows. In my opinion, no mutual fund is substantially identical to another. That said, you should be wary of selling, for example, one S&P Index fund for a loss and then buying into another S&P 500 index fund within 30 days.
Also, don't think you can have your spouse buy identical replacement securities without running afoul of the wash sale rules. Your tax loss is still disallowed. Ditto if your controlled corporation or IRA makes the buy, according to the IRS.
What Happens to Your Loss? The only good news about wash sales is that your disallowed loss doesn't just go up in smoke. Instead, it gets added to the basis of the replacement securities. When you sell them, your disallowed loss effectively reduces your gain or increases your loss on that transaction. Also, the holding period of the wash sale securities is added to the holding period of the replacement securities, which increases your odds of qualifying for the favorable 15% rate on long-term capital gains.
Link: http://www.smartmoney.com/personal-finance/taxes/understanding-the-wash-sale-rules-9860/?hpadref=1
Next week to finish off this series we'll discuss the practical aspects of tax harvesting and why you must use this for longer term portfolio performance.
posted by CR English at 6:05 AM
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