IRS & Your Capital Gains (or Losses...)
While investment decisions are seldom made on the basis of tax consequences, these consequences can be managed with a little planning.
Timing
No gain or loss is recognized until the stock is sold. This is a tremendous tool for managing tax consequences (wait until January to take that gain, or take the loss in December). The ultimate way to beat the capital gains tax is to die (many many years from now) owning the stock.
Capital Losses
If you have a net capital loss (losses minus gains) for the year, up to $3000 ($1500 if married filing separately) can be deducted. Anything beyond that is carried to the next year, and included in that year's calculation of net capital gain or loss.
Tax Lots
When only part of a position is sold, how do you determine which shares were sold?
Example:
8/15/06 Buy 100 shares XYZ at $1
5/15/08 Buy 100 shares XYZ at $8
7/11/08 Sell 100 shares XYZ at $5
If you take no action, shares are deemed to have been sold first-in-first-out. In this example, that results in a $400 long-term capital gain. However, you have the option of instructing your broker which shares to sell (if you don't, time for a new broker!). So if you tell your broker that you sold the 5/15/08 shares, you'll have a $300 short-term capital loss (short-term means held 12 months or less. held more than 12 months is long-term). (Brokers have different ways of handling this. E*TRADE allows you to specify lots when the sell order is placed; TD Ameritrade requires you tell them after the sell order is executed.)
Wash Sales
When you're behind on a stock you believe in, it would be nice to get a capital loss deduction and keep the stock. So why not sell and buy back the shares? Because of the wash sale rules - if shares are repurchased within 30 days, you don't get the capital loss deduction. Instead you get to adjust your basis.
Worthless Stock
What happens when that stinky pinky that you bought on a tip from your barber goes belly-up? If the stock is truly worthless (no bids is a good indication), you can report it as sold on the last day of the year it became worthless. Some brokers will buy the stock from you for $1 (and charge a fee) to eliminate the possibility of IRS questioning whether the stock is really worthless.
