You can’t make every stock trade a winner, but you can reduce the taxes on your winners by selling your losing stocks. The Internal Revenue Service offers guidelines for writing off losses against gains, and you must follow these guidelines in order to receive the full tax benefit of selling losing stocks. You can receive maximum tax savings by organizing your sales so that they apply to the specific types of gains you have.
Adding Up the Gains and Losses
When you add up your gains and losses, you must keep your stocks in two distinct categories: long-term and short-term. When you hold a stock longer than a year, count it as long-term. The stocks you held one year or less belong in the short-term category. This categorization applies to both profits and losses, because each category receives a different tax rate. Long-term gains qualify for capital gains taxes, while short-term gains receive the same tax treatment as your regular income. Short-term gains therefore typically incur a higher rate than your long-term gains.
Selling the Right Stocks
If you have long-term gains on stocks, you can sell losing stocks you have held long-term to claim the losses against the gains. You can only apply losses on long-term stocks against the gains on long-term stocks. The same rule applies to short-term stocks. Short-term losers offset short-term winners. Even if your losses exceed your gains in one of the two categories, you cannot apply your "excess" losses to the other category. You must keep long-term and short-term figures completely separate.
Choosing Stocks to Sell
As you approach the end of the year, examine your portfolio to see what kind of profits you have taken on your stocks. If you made money on long-term stocks, for example, find out if you have any long-term losing stocks that make good candidates for selling. Selling your losers will reduce the amount of tax you have to pay on your gains. If, on the other hand, you have not taken profits on long-term stocks, you may be better off holding your losers until a future year when you may need the write-off. Examine your short-term stocks in the same way. If you made a lot of quick profits by selling winning stocks you held for a year or less, consider whether you have short-term losers you should sell.
Selling More than You Need
If you overdo your selling to offset gains, you may not realize all of the tax savings in the same year as the sale. You can only write off $3,000 worth of losses in any given year. If your losses exceed $3,000, you must carry your losses forward. This means you can write off stock losses against gains in coming years. For example, if you make $10,000 in gains on short-term stocks, and you sell $14,000 worth of losers, you can write off $3,000 in losses this year and $1,000 the next year. You must maintain the long-term and short-term categories for losses you carry forward.
The Wash Rule
The IRS will not allow you to claim a loss on a stock if you buy it back within 30 days. This rule prevents investors from creating false losses by selling a stock and then repurchasing it at or near the same price in order to realize gains in a future year and yet receive a write-off in the current year. If you sell a losing stock in December in order to offset gains you made in the previous eleven months, then buy that stock back in January, you cannot claim the loss under the Wash Rule.
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