With the year rapidly drawing to a close, time is running out if you've been thinking about doing some tax-loss selling in order to reduce your tax burden for the year.
With tax-loss selling, the IRS allows you to use your investment losses to offset capital gains, or even as a deduction against your other income if your losses are more than the gains. If you are sitting on losing investments, here is what you need to know about tax-loss selling and whether or not it's the right move for you.
What is tax-loss selling and how can it help you?
Tax-loss selling is basically the strategic sale of a losing investment in order to lower one's tax burden for the year.
The IRS allows for investment losses to be used to offset capital gains, both short-term and long-term. So, if you made $1,000 on the sale of one of your stocks earlier in the year and sell another stock now at a $1,000 loss, you'll pay no capital gains tax at all.
But what if your losses are greater than your investment gains or you didn't have any capital gains at all for the year? If this applies to you, the IRS will actually let you use up to $3,000 in investment losses per year as a deduction against your taxable income. If you have even more losses than that, you can carry over the difference to the following tax year.
Essentially, tax-loss selling is the U.S. government's way of subsidizing your losing investments, and can lessen the sting of selling for a loss. So, should you take advantage of it?
When should you sell at a loss?
Basically, you should consider tax-loss selling if you are sitting on a losing position that you feel has become just a "bad investment." Maybe your reasoning when buying the stock in the first place no longer applies. Or, maybe there is an elevated risk that didn't seem to exist when you bought the stock. Whatever the reason, you aren't in love with the company anymore.
One great example in my own portfolio that I considered for tax-loss selling is Prospect Capital Corporation (NASDAQ:PSEC). I wrote about this situation in more depth recently, but in a nutshell, some of the reasons for which I liked the stock in the first place (steady and increasing dividend, sound management decisions) don't really seem to apply as much anymore. You can read my full discussion on Prospect here, as well as some other stocks my colleagues feel make good tax-loss candidates.
And, when should you hang on?
On the other hand, just because one of your stocks is down does not necessarily mean you should sell it simply to reap the tax benefits.
This is the case when the overall market or the company's sector is taking a beating, but you still like the company and its future potential. In other words, if your reasons for owning the stock still apply, you don't have to run for the hills. I would actually view situations like this more like a buying opportunity than a reason to sell.
An excellent example of this is what is happening in the energy sector right now, particularly with the oil companies. In fact, since oil began its decline, I've been sitting on a pretty substantial loss in several stocks in my portfolio, such as Total S.A. (NYSE:TOT) and Transocean (NYSE:RIG). However, my reasons for buying the stocks in the first place still apply, so I have absolutely no intention to sell either one.
A useful tool, if you need it
To sum it up, just because one or more of your stocks is worth less than you paid for it doesn't mean it's a good candidate for tax-loss selling.
However, if something has fundamentally changed with the stock and you no longer like it as a long-term investment, the option to reduce your tax burden while freeing up your money to invest elsewhere is a pretty nice one to have. And, if you want to sell, you only have a few more days to do it.
Matthew Frankel owns shares of Prospect Capital, Total (ADR), and Transocean. The Motley Fool recommends Total (ADR). The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.