Turn stock losses into tax savings

By Jeff Schnepper

Remember your 401(k)? Before the stock market crash downsized it to a 201(k)? And wouldn't you love to be able to take some of those losses off your taxes?

Sorry, but you can't. Losses inside a retirement account aren't allowable deductions.

But if you have nonretirement investments that have taken a hit, here's some tax-saving salve to soothe the pain.

You have to sell to get a tax break

I hope you were smart and sold your losers last year. If so, you can use those losses on your 2008 taxes.

If you didn't, think about getting rid of them in 2009.

The reason is simple: You get no deduction just because the value of your account went down. To harvest some tax savings, you have to sell the loser securities. Losses aren't recognized until the stock is sold.

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My general rule with stock market investments is that if you wouldn't buy the shares at their current price, sell them.

If you think the value will increase in the future, sell and repurchase.

But be aware of the rules on "wash sales." Regulations disallow a current deduction if you buy the same stock within 30 days of a loss sale, but you could get a deduction later.

Say you sold Microsoft stock for a $2,000 loss and then repurchased the shares within the 30-day period for $10,000. The wash-sale rules would disallow the current-loss deduction, and the Internal Revenue Service would deem the cost of the new shares to have been $12,000. You would get the benefit of the lost deduction when the new shares were sold.

A recent court ruling said the wash-sale limitations apply even if a repurchase is made inside an individual retirement account.

Schnepper's solution? Always, always wait until the 31st day to repurchase.

How to calculate your losses

Losses not subject to the wash-sale limits can provide immediate tax savings. Short-term capital losses (those in which you held the stock for less than one year) are allowed to offset short-term capital gains. Long-term capital losses are allowed to offset long-term capital gains.

Net losses in either category (long- or short-term) are allowed to offset capital gains from the other category.

If, after all the netting, you still have a loss, up to $3,000 of that loss can be used to offset other, ordinary income. Net short-term losses are used first, then net long-term losses.

Let's say you have the following:

• Long-term capital gains of $10,000.

• Long-term capital losses of $12,000.

You now have a net long-term loss of $2,000. Now let's say you have these:

• Short-term gains of $3,000.

• Short-term losses of $9,000.

You now have a net short-term losses of $6,000.

Your total net loss is now $8,000, of which $3,000 can offset ordinary income and $5,000 can be carried forward into the next year. If you made all the sales in 2008, you can use $3,000 to offset 2008 income and the rest on your 2009 taxes, to be filed in 2010.

If you're in the 25% bracket, that $3,000 offset will save you $750 in taxes. Since net short-term losses are used first, you carry over $3,000 in short-term loss and $2,000 in long-term losses for your 2009 return.

If you make those sales in 2009, you can take $3,000 on your 2009 return and the rest on your 2010 return.

Continued: Dealing with short sales

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