It's Harvest Time for Losing Stocks

Even though the stock market has climbed more than 70% from its low back in March, many investors find their portfolios are still loaded with clunkers. Some of them may come back; others may be doomed to the cellar for months to come. As year-end approaches, it may be time to take a look at these losing investments to see if selling them can save you money on your income taxes.

This selling strategy, called tax-loss harvesting, involves cashing out of losing stocks or mutual funds and using the losses to offset gains in winners or writing them off against ordinary income. If you bought 100 shares of stock in XYZ Inc. at $50, for example, and it’s now selling for $40, you have a $1,000 loss when you sell. You can use that loss to wipe out gains in investments that you made money on when you sold them. If your losses are more than your gains, you can deduct up to $3,000 against ordinary income on your Form 1040. If your losses versus your gains total more than $3,000, you can carry any excess forward into future tax years, either to minimize capital gains in those years or to write off against future income.

The twist in this strategy is called a “wash sale.” If you sell a stock or mutual fund for a loss and buy a substantially similar stock or mutual fund with 30 days before or after you sell, you can’t claim the loss. The problem is that the IRS hasn’t clearly defined what a substantially similar investment may be. If you sell Vanguard’s S&P 500 index fund, for example, and buy Fidelity’s S&P 500 index fund, is that a wash sale? It’s best to talk to your tax advisor before making any tax-related moves.