Easing the Sting
Market losses can turn into benefits on your tax return by offsetting gains and other income
After three years of a bummer stock market, your tax return may actually provide some bittersweet consolation by reducing the pain of losses. And with President Bush proposing elimination of taxes on dividend income, the tax code might provide a future silver lining for investors.
The existing salve is that losses on the sale of stocks or mutual fund shares are deductible. That can lessen the tax on gains you enjoyed or ease the bite on wages and other income. Some caveats: Paper losses are not deductible unless you cash out. And losses in 401(k)'s are not deductible. "The IRS is actually pretty stingy, but if you have losses, you might as well get the best out of them that you can," says Thomas Ochsenschlager, a partner in Grant Thornton accountants' Washington, D.C., office.
How much can you deduct? There's no limit when offsetting gains on sales of stocks or mutual fund shares. If you didn't have profits, though, or your losers exceeded your winners, you can deduct up to $3,000 of losses to reduce regular taxable income such as wages or interest. Losses beyond that can be carried over indefinitely for deduction in future years. So, for example, if you sold one block of stock last year at a $5,000 profit and another at a $9,000 loss, the loss lets you avoid tax on the $5,000 profit and on $3,000 of wages, with $1,000 of the loss carried over.
Cleaning house. The door to trimming 2002's tax pretty much closed on December 31. But portfolio house cleaning should be a yearlong endeavor, says Michael Radford, a financial adviser in Charlotte, N.C., with the accounting firm of Deloitte & Touche. Consider shuffling holdings throughout 2003 by taking losses and gains to offset each other, he advises. But watch out: If you sell a stock for a loss, you must wait 30 days before buying the shares again for the tax deduction to be allowed.
If you had losses in past years that you couldn't fully deduct because of the $3,000 cap, check the tax form instructions to possibly claim some of the losses on your 2002 return. Proposals to lift the cap have faltered, so for some taxpayers with large undeducted losses and no gains, this can be an annual ritual.
But there's some real, though modest, simplification starting with 2002 returns. Taxpayers who receive dividends and interest will now be able to report up to $1,500 of such income without listing specific payers and amounts. That ceiling replaces the previous $400 threshold and will mean one less tax return page for some 15 million filers.
All the attention given to the 1040 can pay off. Still, financial planner William Goldberg at the Houston office of accountants KPMG offers a timeless caution: "The savvy investor is aware of taxes but not mesmerized by them."
This story appears in the January 20, 2003 print edition of U.S. News & World Report.