Please ensure Javascript is enabled for purposes of website accessibility

The Easy Remedy to Avoid a Nightmare in April

By Dan Caplinger - Updated Apr 5, 2017 at 7:55PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Make the right choice when you sell your investments.

Investors have had plenty of nightmares over the past year as they've watched their portfolio values plunge. To keep from experiencing yet another nightmare next April, though, you can take steps now to keep your taxes simple while letting you make the most of the losses you've suffered.

As we approach the last week of the year, time's running out if you want to sell investments to harvest tax losses. If you just hit the sell button without considering all of the choices you have with your tax-loss selling, you could create a big headache for yourself -- one that you could have avoided.

The ways to account for sales
In accounting for sales of investments, you have to figure out how much gain or loss you have on your position. That number, in turn, depends on the cost basis of the shares you sold.

If you sell all of your shares, then your basis is just the total amount you paid for the shares, including any commissions. If you get less than that amount when you sell, you have a loss; if you get more, then you have a gain.

Where it gets tricky, though, is when you sell only part of your holdings. Then, you have several choices to determine cost basis:

  • The default method is to look at the shares you bought first and take what you paid for them as your cost basis.
  • However, you can also specifically identify shares when you sell them, which lets you sell shares you bought later if you want.
  • With mutual funds, you can also use one of two average cost methods, in which you divide the number of shares you bought over time by the total of what you paid for them.

Sound easy? It's not -- especially if your broker isn't totally cooperative with great record-keeping.

What's at stake
But it's still worth the extra effort to look over all of your options. If you regularly invest and have bought shares of the same stock or mutual fund at various times, picking the right method can save you thousands on your taxes. You might have gains on long-held shares but losses on others. If you're not careful, you could turn your intended tax loss into a gain.

For instance, if you bought shares of the following stocks five years and one year ago, you'd be much better off selling the shares bought one year ago:

Stock

5-Year Average Return

1-Year Total Return

Apple (NASDAQ:AAPL)

54%

(55.8%)

Caterpillar (NYSE:CAT)

2%

(41%)

Dominion Resources (NYSE:D)

5.4%

(26%)

Kimberly-Clark (NYSE:KMB)

1.4%

(21.4%)

Lockheed Martin (NYSE:LMT)

11.4%

(27.2%)

Monsanto (NYSE:MON)

37.8%

(40%)

Teva Pharmaceutical (NASDAQ:TEVA)

9.1%

(6.4%)

Source: Yahoo! Finance as of Dec. 22.

Unfortunately, you can't go back after the fact and pick shares to sell. Instead, you need to tell your broker up front which shares to sell and ideally get written confirmation that your broker followed those instructions.

Funds and average cost
With mutual funds, you have another choice: You can use one of two average cost methods. With one, you look at all your shares. With the other, you divide your shares into long-term (more than a year) and short-term holdings and then do separate averages for each.

One advantage of average cost is that many fund companies provide this information to you on your year-end tax forms. Given how hard it is to keep track of all the fractional shares involved with purchases and reinvested dividends, your fund company can be a lifesaver at tax time.

However, you may still be better off specifically identifying shares. If so, the rules for identifying shares are the same as for stocks -- get written confirmation from your fund company of the shares you choose.

In addition, once you pick an average cost method for a fund, you have to keep using that method in future years. So be sure you're ready to commit before you use either method.

Be tax-smart
Dealing with tax issues intimidates even the most experienced investors. With a little basic knowledge, though, you can take maximum advantage of the rare benefits the tax code gives investors.

For more on dealing with the bear market:

Tax questions? Our Rule Your Retirement newsletter service has the answers you need on the tax matters that matter most to retirees and aspiring career savers alike. You'll get helpful reminders about tax deadlines, along with more information on tax breaks. See everything Rule Your Retirement has to offer with a free 30-day trial.

Fool contributor Dan Caplinger has a ridiculously complicated spreadsheet to track his investments. He doesn't own shares of the companies mentioned in this article. Kimberly-Clark is a Motley Fool Income Investor recommendation. Apple is a Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy wishes you sweet dreams.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$168.49 (-0.44%) $0.75
Kimberly-Clark Corporation Stock Quote
Kimberly-Clark Corporation
KMB
$134.63 (-0.76%) $-1.03
Caterpillar Inc. Stock Quote
Caterpillar Inc.
CAT
$194.00 (1.72%) $3.28
Lockheed Martin Corporation Stock Quote
Lockheed Martin Corporation
LMT
$428.85 (-0.27%) $-1.14
Dominion Resources, Inc. Stock Quote
Dominion Resources, Inc.
D
$81.76 (-0.46%) $0.38
Teva Pharmaceutical Industries Limited Stock Quote
Teva Pharmaceutical Industries Limited
TEVA
$11.09 (-0.98%) $0.11
Monsanto Company Stock Quote
Monsanto Company
MON

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
390%
 
S&P 500 Returns
125%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/12/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.