The dreaded December effect
Each year investors of all sorts and account sizes utilize their stock losses to rack up huge tax gains. Individuals are able to sell off depreciated stock to offset capital gains. Investors are able to match up however large losses against gains ($50K loss against $50K gain= 0 capital gain and no tax). Investors can also opt to take up to $3000 more in losses than gains, thus resulting in a drop of income by $3000. Any amount above $3000 can be carried over and deducted the next year.
The IRS to counteract selling to reduce taxes introduced the Wash Sale rule which prohibits a loss deduction if the investor buys or sells a similar security 30 days before or after the sale. For example, buying 500 shares of Yahoo on December 1 and selling December 22 would not qualify for a deduction. Nor would selling December 22 and buying on January 3.
Even with steps in place to stop Tax loss selling it is very popular, and should be. Selling December 1 then buying January 3 is completely legal and a great way to shelter gains or to reduce ordinary income. This time around the December effect will likely be huge with all investors carrying some kind of loss that they would be happy to write off.
This December is even more important because it comes in a weak year with already existing fears of a weak 4th quarter for most businesses. And with the market on critical support levels its going to be a doozy on the markets. Starting December 1 the tax loss selling will start to begin which will put excess selling pressure on even the best of names. If you haven’t thought about dumping some losers, December 1 would be a great time to do so; allowing you to buy back in January when trading begins in a new year.
Word of Advice
If you plan on dumping stock for a tax loss know the law. You cannot sell then buy similar securities. You cannot sell Exxon Mobil then buy Exxon Mobil, you CAN sell Exxon Mobil and buy Conoco Philips on the other hand. There is a gray area that exists in IRS code that would allow you to sell a Fidelity Index fund and buy a Vanguard index fund though it would not be advisable. Often times you can buy similar securities without being too similar.
For example an “emerging market” and “global” fund are entirely different though they may be exposed to the same markets and thus generate similar returns. If you want to take the loss but get back in ASAP, this is a great way to do it. Talk to a tax advisor before buying or selling anything though, it will save you time and give you more input on IRS code.
