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Cut Your Taxes Without Selling Low

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As we start winding our way toward the holidays, investors eager to cut their income taxes start looking at their portfolios for stocks that have lost them money. Selling your losers lets you lock in a capital loss that you can use on your taxes to offset gains on other stocks, as well as some other forms of income.

Unfortunately, there's no shortage of losing stocks this year. Shares of companies like Mosaic (NYSE: MOS  ) , Caterpillar (NYSE: CAT  ) , and Sears Holdings (NYSE: S  ) have dropped 50% or more this year. Many financial stocks, including Wachovia (NYSE: WB  ) and Merrill Lynch (NYSE: MER  ) , have lost even more.

If a stock's price decline has convinced you that you're well rid of it for good, then the choice is easy -- just sell. But if you think your stock is poised for a rebound, the question of selling gets far less simple.

Don't get washed
Ideally, you'd like to claim your tax loss by selling your stock, but then buy it right back before the price goes back up. Unfortunately, the tax laws don't let you do that. According to the so-called "wash sale" rules, you can't claim a tax loss if you buy back the same stock within 30 days of when you sell it.

That month of waiting can create a big problem. If the stock bounces during that 30-day period, you'll have to pay a higher price to get your stock back. You earned your tax loss, but you ended up losing even more money by selling low and buying higher.

Fortunately, if you're bullish on a stock, there's a way you can both reap your tax losses and benefit from a rebound.

Reverse your thinking
The key to the wash-sale rules is that there has to be a 30-day period between when you sell shares and buy the same shares. But the rules don't specify that you have to sell before you buy. So to stay invested in a stock, buy "back" your shares first. Then, after 30 days, you can sell your original shares, leaving yourself with the same number of shares you started with.

Using this strategy means that instead of having no shares for 30 days, you'll have twice as many shares as you originally bought. So if the price goes up, you won't just make money -- you'll make double the money. Of course, if you're wrong about a potential rebound and the stock keeps going down over that 30-day period, you'll have doubled your losses.

But if you're willing to take the risk of further losses to avoid missing a rebound, doubling down is the way to go. You won't always be right, but you'll never have to beat yourself up about missing out on a big move up.

Check out these articles to learn more about:

Get more tax-planning ideas by visiting our collection of tax articles and information.

This article was originally published on Oct. 24, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned in this article. Sears Holdings is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is never taxing.


Read/Post Comments (4) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 25, 2008, at 4:47 PM, Decibel45 wrote:

    http://fool.com/taxes/2002/taxes021018.htm disagrees completely with this article. It explicitly states that it's considered a wash sale if you buy within 30 days BEFORE OR AFTER the sell.

    I think the Fool needs to get it's facts straight, on way or the other...

  • Report this Comment On October 27, 2008, at 12:47 PM, nhpete wrote:

    This article is completely wrong about wash sale rules. It needs to be deleted.

  • Report this Comment On October 27, 2008, at 8:18 PM, fokcal wrote:

    Reading the subsequent notes re: "wash sales' WHAT'S THE ANSWER? It sounds as though you are totally wrong!!!!!

  • Report this Comment On October 27, 2008, at 8:19 PM, fokcal wrote:

    Hey! I sent you a comment...

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