Due to the recent bear market that has presented itself in the year 2001 there will be many stocks and mutual funds that will end the year down. Many investors with long term objectives can handle the bear market, but many individual investors have a tough time creating paper losses to offset realized gains through tax-loss selling. Here are a few things to learn that will help you get a grip of what you will have to pay towards taxes this year.

While many investors have unrealized losses in your portfolio, Tax laws do not allow you to take a loss until you actually sell the stock or mutual fund. Once you have taken the loss you have created a realized loss. This can be beneficial to lowering your taxes. But first, there are a few guidelines set by the IRS that you should be aware of on how you take your loss.

Part 1 ~ Reducing Your Tax Liability

Take the time to review your portfolio to decide if there are investments that are showing an unrealized loss since the purchase of them. For example, if you have an investment that you paid $20,000 for and it is now worth $15,000 you have an unrealized loss of $5,000. This applies to both mutual funds and stocks. If you have realized gains of investments that you sold for a gain that totaled $10,000 in realized gains then take that amount and subtract $5,000 that you have in realized losses you now have $5,000 in taxable capital gains. At a tax rate of 20% applied to $5,000 in tax loss you will have a savings of $1,000. Keep in mind there are consequences in case you decided that you would like to purchase the same investment that you originally sold for a loss.

Part 2 ~ Some Rules For Tax Loss Selling

If your net loss exceeds $3,000, you cannot write off the entire loss against other income such as wages, interest, and dividends. Your net loss is the total of all your capital gains minus all your capital losses. If your tax losses are greater than $3,000, you can write off $3,000 against your income and the balance can be carried forward for use in future tax years. This is important when selecting which investments that you want to sell for tax loss purposes. It is always good to keep records of these losses for future use.

The IRS has a guideline known as the wash-sale rule. These are limits on buying a stock that you have just sold for a tax loss. The wash-sale rule stops you from deducting a loss on the selling of a stock or mutual fund if you buy an identical security on the same day of the sale or within 30 days before or after the day you took the loss.

Example: On March 1st you sell 500 shares of AOL for a loss. On April 20th you buy 500 shares of AOL. The sale on March 1st is considered a wash sale. The wash sale applies to any sale at a loss 30 days before and 30 days after the sale of that particular stock or mutual fund. Please keep in mind that this is applied towards calendar days and not business days. It can be beneficial to contact a local accountant to help guide you through tax-loss selling.

This editorial is for informational purposes only. Please speak with a public accountant due to the ongoing changes in tax rules. Please read our disclaimer.