Most people invested in the stock market in 2008 had their head handed to them, and had large losses. The good news is that many stocks have rebounded since then. Careful tax planning can make a difference.

When you sell stocks, bonds, mutual funds, and most other investments, you are left with what is called a capital gain or loss. Currently, these gains are taxed at a maximum rate of 15%, while ordinary income rates go up to 35%. Two issues regarding investment sales that you need to review:

  1. Generally, if you have net losses, you can only take $3,000 in that year, with the remainder carrying over to subsequent tax years. Any future years that you have gains, you can use those losses to offset those gains. It is not uncommon to have gains in one year that you have to pay taxes on, while the next year you have a loss that is limited.
  2. You have to group short-term (less than one year) losses and gains together, and long term (one year and one day) losses and gains together. With the tax rates going up next year, you want to make sure you minimize short-term gains in 2011 (they’re taxed at your highest tax rate just like ordinary income). After that, they are netted against each other. Short answer is, you really need to review the timing of your stock and bond sales.

So what does this look like? An example of a strategy would be to recognize assets with gains in 2010, and push the losses into 2011 (especially short term ones). This would take advantage of the lower capital gain rate (15%) on longer term gains, while pushing short-term losses until next year, when there will be higher rates. Of course you don’t want this to be the tail that wags the dog. These sales need to be consistent with your investment goals and your risk. Don’t buy or sell an investment just because there is a tax reason.

Lastly, some smart investor might say, “Well I have a loss with a stock, but I really think it is a good long term investment. I will just sell it before the end of the year, take the tax loss, and then January 1 buy the same stock back again.” The IRS is already a step ahead of you. The so-called “wash sale” rule prevents you from taking a loss when you purchase the identical security within a 61 day period (30 days before, and 30 days after).

Bottom line is, carefully review your transactions headed into the new year. Consider taxes in all of your financial decisions. Remember, after tax return is the only return that matters!

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