Take loss, ease tax
NEW YORK – It’s been a terrible year for the stock market but there may be a consolation prize in it for some investors: a tax loss that can help them offset their income.
Investors who don’t want to wait for their stocks to recover might decide it’s better to sell and reduce what they owe in taxes for 2008 or future years. Dumping weaker parts of a portfolio to offset taxes seems obvious when returns are hefty, but it can make just as much sense in rough years.
With the stock market down more than 40 percent this year, some investors might be surprised to find they owe taxes even as the value of their investments has tumbled. Some who sold earlier this year when markets were higher might see relief turn to disappointment when the tax bill arrives. And even those who have stayed invested could take a hit – some funds had so many shareholders getting out that managers were forced to sell investments that would trigger capital gains taxes.
“That’s a big whammy for a client when your portfolio is down 40 percent but you’ve got a 10 percent capital gain,” said Thomas Ruggie, president of Ruggie Wealth Management in Tavares, Fla. “Clients don’t take that very well.”
He has advised most of his clients to sell some holdings this year to reap the tax benefits. Some will use the losses to offset what they owe for 2008 while others will apply the losses to reduce taxes in future years.
“There is absolutely no reason that anybody should pay capital gains taxes in a year that the losses are as large as they are,” Ruggie said. “If you’ve got gains you’ve got to offset, you’ve got to be selling something.”
A spokeswoman for Fidelity Investments, the world’s largest mutual fund manager, said the company expects fewer of its funds will pass along capital gains to investors for 2008 and that the amounts likely will be smaller than in previous years. The funds most likely to have capital gains are those tied to investment areas like commodities, which soared in the first half of the year.
Doris Merrick, tax director at Brinton Eaton Wealth Advisors, a financial planning firm in Madison, N.J., said investors should guard against hasty selling simply to sidestep capital gains taxes.
“You cannot let the tax tail wag the investment dog. You don’t want to give up a good investment of yours to avoid some taxes at 15 percent,” she said.
Investors who don’t want to make big changes to their holdings can consider swapping an investment for one that is similar. This lets them record a loss without greatly altering their investment strategy.
And even investors who aren’t facing hefty taxes this year can apply the tax loss in future years, when their returns might be greater.
There are other benefits, too. Trimming some investments with an eye toward reducing taxes might bring comfort after a tumultuous run in the market, Merrick said.
“This is one way to make you feel like you have a little bit more control.”