Capital gains taxes and deductions

[jteezie]

I have some very poorly performing stocks which I think I should sell for a loss and claim the tax deduction then buy back or buy a close competitor in the industry. I am not sure how this works.

Can someone explain the best way of approaching this to maximize the tax benefit and minimize my losses.

Thank you in advance.

[jpg7n16]

You wouldn't be able to claim the loss if you bought the security back too soon due to the wash sale rule.

You should really read this: What is a Wash Sale? - TurboTax® Software Support

Questions:

• How much of a loss are you considering taking?
• Do you have other capital gains you are trying to offset?
• Or are you hoping to deduct the entire amount against your income? (you likely can't)

[jteezie]

It sounds like this may not be as advantageous as I thought. I was hoping to offset it against income, but that doesn't seem likely from your input.

I am looking at about $5500 in losses, but I don't really have much in my taxable accounts to offset it nor would I want to as my other holdings with gains are long term gains, so it wouldn't really make sense for the most part. I used my taxable account for higher risk investments. The losses are from green energy investments which took a bit of a hit after the Solyndra scandal (though I admit, that incident likely triggered a more fundamental issue underlying market/stock valuations).

I haven't claimed any capital gains this year as the market is pretty volatile and I'm more of a buy/hold investor. From past experience, the concept of market timing in a volatile market (buy low, sell high) seems great, but is very hard to execute well.

Any suggestions or do you need more information?

[jteezie]

And thanks JPG for being such an active contributor to our boards. You seem quite knowledgeable and involved in stock investing.

[jpg7n16]

It sounds like this may not be as advantageous as I thought. I was hoping to offset it against income, but that doesn't seem likely from your input.

I am looking at about $5500 in losses, but I don't really have much in my taxable accounts to offset it nor would I want to as my other holdings with gains are long term gains, so it wouldn't really make sense for the most part.

Well you kinda can, but kinda can't. Capital losses (like short/long term cap gains) are 1st netted against other capital gains. Then if you have more losses than gains, you can deduct up to $3,000 against your ordinary income, and can carry forward the excess loss to future years (unlimited years).

What that means to you. If you sold your position and realized the $5,500 loss this year:

$0 gains
5500 loss
-(3000) current year deduction
2500 remaining loss carried forward to next year (possible deduction next year)

That may not be too bad, though you wouldn't get to deduct it all this year. I was really concerned that you may be trying to deduct like $15-50k of losses or something. Only taking $3k when you were expecting $50k would be a pretty raw deal.

Oh something to note - if you sold company ABC and bought ABC again, you couldn't deduct anything (due to the wash sale as seen above). But if you sold company ABC and bought company XYZ, you could deduct the loss. Just wanted to make sure that was clear.

It just can't be equivalent to the same security. Like selling ABC stock and buying back ABC stock within 30 days, or selling ABC stock and buying an ABC stock option, etc.

From past experience, the concept of market timing in a volatile market (buy low, sell high) seems great, but is very hard to execute well.

Any suggestions or do you need more information?

Other than just being curious about why the energy sector, and the specific stock you picked, not really. What was the play there? What did you see? How were you trying to time the market?

Do you have any other questions about the tax implications of that transaction?

And thanks JPG for being such an active contributor to our boards. You seem quite knowledgeable and involved in stock investing.

Thank you so much I like helping people when I can, and am really glad that you're finding my posts helpful. Thanks!!

When I grow up, I wanna be like DisneySteve

[jteezie]

The two stocks I was considering doing this with are JKS and OCTI. I have some others which I am OK holding an unrealized loss on. I wasn't trying any market timing on any of these. My market timing comment was in reference to past experience with the March 2009 rally when day trading in the crazy market actually caused me to underperform the overall market gains.

I was up as much as 250% on JKS, but got caught up with work so I didn't pay attention for a few months... so sad.

OCTI is a local startup in my area. I know the management, CEO included, so I have faith in him and his team for the long run. I'd consider some of them successful serial entrepreneurs.

I realize I'm starting to need to do more complex tax planning... not looking forward to this...

[disneysteve]

What that means to you. If you sold your position and realized the $5,500 loss this year:

$0 gains
5500 loss
-(3000) current year deduction
2500 remaining loss carried forward to next year (possible deduction next year)

That may not be too bad, though you wouldn't get to deduct it all this year.

It just can't be equivalent to the same security. Like selling ABC stock and buying back ABC stock within 30 days, or selling ABC stock and buying an ABC stock option, etc.

Exactly. You do get to take the deduction, just not necessarily all in one year. And you can rebuy the same security. You just need to wait more than 30 days.

Thank you so much I like helping people when I can, and am really glad that you're finding my posts helpful. Thanks!!

When I grow up, I wanna be like DisneySteve

Thank you, jpg. I enjoy your posts as well and certainly appreciate knowing that others enjoy mine.

[jteezie]

JPG, I have a follow up question - more situational...

At what amount of deductions would it make sense to sell these holdings and claim them as additional deductions? (as opposed to just taking the standard deduction and holding these stocks because I assume that if I take the standard deduction, I can't claim this capital loss).

Thanks

[jpg7n16]

JPG, I have a follow up question - more situational...

At what amount of deductions would it make sense to sell these holdings and claim them as additional deductions? (as opposed to just taking the standard deduction and holding these stocks because I assume that if I take the standard deduction, I can't claim this capital loss).

Thanks

Your assumption isn't actually true. The $3000 capital deduction is not an itemized deduction, but rather an above the line deduction. (much like traditional IRA contributions)

As long as you qualify, you get to deduct traditional IRA contributions regardless of whether you itemize or not. It is a separate calculation.

Similarly, you also get to take your $3k capital loss deduction regardless of whether you itemize or not. It is a separate calculation.

Publication 550 (2010), Investment Income and Expenses
Tax Topics - Topic 500 Itemized Deductions

(fyi - same goes for student loan interest - which is also not part of the itemized deduction, but is a separate deduction)


The primary reason for the sale of the security should be that you don't want to own it in your portfolio anymore, not just to get a tax deduction. (But getting a tax break does help )

[jteezie]

Wow. That's fantastic news. I'll get quite a few tax breaks this year I think.

Now as for these securities, it just seemed to make sense to reduce my taxes at my higher marginal tax bracket and then when I rebuy the shares later and hold for over a year, I would pay capital gains tax of 10%. I get the sense that this tax arbitrage is one way that wealthy people seem to keep getting wealthier and why they care so much about tax and estate planning.

[jteezie]

Additional follow up question and idea... Is this idea feasible?

So I'm not very fond of the whole market volatility, but I know it's important to keep my money invested in my 401k for the long run (smoothed out hopefully) returns.

I thought why hope for the market long run if I can guarantee myself a 8% return. I would do this by borrowing against my 401k and investing that money into a taxable brokerage account. This way I maintain exposure to the market risk, but I can deduct the losses (if they happen to be really bad). The true benefit however is that I have to repay my 401k at my predetermined interest rate (lets say 8% here). By doing this, I am possibly putting more money into a tax sheltered account than I otherwise would be able to, I reduce market volatility risk, and I create a better tax situation.

Does this work (assume my company allows it, which I think it does)? Another underlying assumption in this strategy is that economic growth will be dismal over at least the next year, so a risk free rate of 8% will be better than the market return.

[jpg7n16]

Wow. That's fantastic news. I'll get quite a few tax breaks this year I think.

Now as for these securities, it just seemed to make sense to reduce my taxes at my higher marginal tax bracket and then when I rebuy the shares later and hold for over a year, I would pay capital gains tax of 10%. I get the sense that this tax arbitrage is one way that wealthy people seem to keep getting wealthier and why they care so much about tax and estate planning.

FWIW - you seem to very concerned about tax planning too. You don't need to be wealthy to worry about those.

There's a much simpler explanation for why the wealthy worry about taxes and estate planning: it costs them more than it costs you. Especially since you need over a $5 million estate before estate tax kicks in.

But the reason they are wealthy is not because they save money on capital gains - it's because they make so much money in the first place. When you make a $500k salary, it's much easier to build wealth than when you make $50k.

Additional follow up question and idea... Is this idea feasible?

So I'm not very fond of the whole market volatility, but I know it's important to keep my money invested in my 401k for the long run (smoothed out hopefully) returns.

I thought why hope for the market long run if I can guarantee myself a 8% return. I would do this by borrowing against my 401k and investing that money into a taxable brokerage account. This way I maintain exposure to the market risk, but I can deduct the losses (if they happen to be really bad). The true benefit however is that I have to repay my 401k at my predetermined interest rate (lets say 8% here). By doing this, I am possibly putting more money into a tax sheltered account than I otherwise would be able to, I reduce market volatility risk, and I create a better tax situation.

Does this work (assume my company allows it, which I think it does)? Another underlying assumption in this strategy is that economic growth will be dismal over at least the next year, so a risk free rate of 8% will be better than the market return.

I really don't like this strategy at all. And here's why

The goal of financial investing is not to maximize the value of your 401k, but rather to maximize your entire net worth.

In order to 'guarantee' yourself an 8% 'return' (which isn't even what you're doing), you would just be moving more money from your cash to your 401k. That 8% return is offset by an 8% expense. So you gain nothing at all on the whole deal.

Add to that the fact that in order to borrow against the 401k, you have to liquidate some of the investments in it, you just end up having less in your 401k as a strategy to have more in your 401k. It's counterproductive.

And taxwise, you are paying yourself 8% interest with after tax money (taxed once), you do not get to deduct interest on a 401k loan, but you will have to pay taxes on the interest when you withdraw it in retirement (taxed twice).



This 'strategy' is equivalent to this made up one:

How to boost your income by $500/month guaranteed! All you have to do is transfer $500/month from your EF into your checking account. The transfer will make it so that you have $500 more each month available in your checking account. It's like a bonus every month!

Please tell me you see the futility of such a strategy. Well yeah you've got more in your checking, but you've got less in your EF! Your income didn't increase at all, you just shifted money around... so you didn't earn anything. The same logic applies to your 401k strategy.


Moral of the story: You are not making an 8% return. You are working against yourself.


If you are that concerned about the market, just change your 401k allocation to a more conservative one.

[jteezie]

Thanks for your thoughts, but I need to clarify the idea.

the idea is to reclassifying taxable money into a tax sheltered roth 401k (I should have specified roth to avoid the double taxation issue you mentioned). Yes this is just shifting money around but it is changing one's risk and tax profile.

Typing from phone is hard, but let me know if I need to clarify more

[disneysteve]

I thought why hope for the market long run if I can guarantee myself a 8% return. I would do this by borrowing against my 401k and investing that money into a taxable brokerage account.

How exactly would that guarantee you an 8% return, or any return for that matter? You need to pay interest on the 401k loan. You need to pay taxes on any earnings from the brokerage account. In order to earn 8%, the investments would have to generate a high enough return to pay the taxes, pay the interest on the loan AND leave you with a profit after that. There is no investment in the world that can do that and guarantee you a positive outcome.

[jteezie]

I think I'm not being clear with the intent of this plan.

The 8% guaranteed return is because the loan is contractually structured at an 8% interest rate (I set the rate because I am lending to myself).

I am paying the 8% rate with my own money so the money is simply shifting from taxable status into a tax exempt Roth 401K. I am not magically earning 8% out of thin air. The returns I would otherwise make on investments in my 401k become returns in a taxable account. IF I assume there will be little to no growth over the next year, I won't make any capital gains so there won't be any taxes.

I agree that I would need to earn enough returns to offset any capital gains taxes, but if the goal is to reduce risk of loss and guaranteed growth on tax exempt Roth 401k money, then this strategy is a success.