Got long-term stock gains and losses? Lucky you

By Jeff Schnepper

Maybe you're lucky and made an absolute killing on a stock. Congratulations, the rest of us are envious.

But what about those losers you sold before the end of the year? Not to worry. Those dog investments can actually save you money at tax time.

The game is called capital gains and losses. To win it, you've got to know the rules. Please don't look for logic or some sort of grand framework. These rules are the final result of political negotiations rather than any real cognitive thought.

Capital gains result from selling a capital asset -- stock, bond, mutual fund, apartment building, diamond -- for more than its "basis." For most people, basis is what they paid for the asset, including transaction costs.

You pay taxes on the gain or profit. If you sell a stock for a profit in a year or less, you get a short-term gain, which is taxed at your regular tax rate, as much as 35%.

You do get taxed less on your gains

If you have owned a stock for more than a year, you can sell it and pay taxes up to a maximum of 15%. The rate depends on your taxable income. The lower capital gains rate (which applies to taxpayers in the 15% bracket or lower) is zero percent this year!

Let's deal with a simple case. Let's say you're in the 28% bracket, and you had a long-term gain of $10,000 in, say, Google. The lower capital gains rate saves you $1,300. (That's $2,800 if the gain is taxed at ordinary rates less $1,500 because you've held the stock for more than a year.)

How you can make a loser pay

If you have an investment that's a loser, you can use the loss to offset any gains, like that big Google gain, and neutralize or at least reduce the tax effect. To put this opportunity to work, note these three conditions:

• You must have taxable gains and losses. You can't deduct your losses in an individual retirement account or a 401k account.

• Long-term capital gains are first matched with long-term capital losses.

• Short-term gains have to match with short-term losses.

So, how to make this work for you?

Let's say you have a net long-term gain from selling several stocks and a net short-term loss from selling several stocks. You can offset the long-term gain with the short-term loss. If, at the end, you have a net loss from all stock transactions, you can use up to $3,000 in losses to offset ordinary income. The remainder can be used in subsequent years until it's used up.

Let's say you bought 100 shares of Systems in January 2000 at $60 and 100 shares of Corp at $20. Systems is now selling at $28. That means you face a long-term loss of $3,200.

Corp is quoted at $54, giving you a long-term gain of $3,400. You can use the loss in Systems to offset nearly all the gain of Corp. You would pay tax only on a total gain of $200.

Continued: The subtleties of basis

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