Published 12/30/07 (Modified 3/8/11)
By MoneyBlueBook

Is your stock portfolio making you sad? Are you bummed out about your disappointing returns and contemplating selling your positions to stem the losses? If so, fear not, Uncle Sam has a tax system in place to help lessen the financial pain and make your situation more bearable.

If you've lost confidence in your stock positions, maybe it's time you cut your losses to take advantage of tax breaks that can help you avoid having to pay taxes on other realized gains for the year. Perhaps you owned stocks that were hit particularly hard, like Countrywide Financial or even ETrade, both with grim and uneasy future prospects. Holders of such dubious positions might want to contemplate selling their shares now to lock in their losses by the impending January 1 deadline for tax purposes.

It's Best To Push Tax Bills Into The Future And Accelerate Deductions Into The Current Year

Generally, the Internal Revenue Service (IRS) allows you to deduct capital losses from capital gains and other income. Since we are so close to the end of 2007, it's best to postpone any further gains that could be treated as taxable income a few days more, at least until January 1. If you have loser stocks that you can sell without any regret, now is the time to do so before the start of the new year. If you can unload enough of these losing positions, you might be able to completely wipe out all of your other realized capital gains for the year. Even if you don't have enough realized gains to offset, you can still deduct up to another $3,000 towards your regular earned income.

Excess Capital Losses Can Be Carried Over and Applied Towards Future Tax Returns

If you dumped too many losing stock positions during the year and the extra $3,000 isn't enough to offset for tax purposes, you are allowed to carry the excess losses into future tax years to reduce future capital gains. The amount can be carried over indefinitely without limit until the losses have been used up. The IRS will likely keep a running tally of the amount you have left to deduct, but if you consistently use the same online tax program such as Turbo Tax or H&R Block's Tax Cut from year to year, the program can help you keep track of your tally based on your past tax returns. I really recommend using an online tax program to help make your record-keeping life easier.

Let's use my past situation to illustrate the carryover loss. In 2000 as a college student, I lost a lot of money in the stock market after the dot com bubble collapsed. Since I had no earned income for several years as a student, I continued to carry over the excess losses until I finally entered the workforce and started generating income. Only recently did I finally use up the remaining carried over losses.

Be Aware of the Tax Loss Wash Sale Rule

With the ability to offset capital gains using capital losses, there are also limits and rules on when and how much you may deduct. The wash sale rule occurs when substantially identical security (stocks) is sold at a loss and repurchased back within 30 days. When this happens, the tax loss will not be allowed to be used to offset any other capital gains for tax deduction purposes because the stockholder ends up in the same economic position before and after the sale - essentially a wash.

If you own a stock that you eventually sold at a loss and you want to use the capital loss for tax reporting purposes, you will need to wait 31 days before buying the same or a substantially similar position. But frankly, if you planned on buying back the stock so soon, perhaps you shouldn't have sold it in the first place. Remember, it's always best to invest for the long term and not get too caught up in short term, emotionally driven market fluctuations.