Tuesday, February 9, 2010

Investing Term Tuesday - Tax Selling.

This week's investing term is all about investment decisions motivated by tax implications. It's called tax selling and as the name suggests, it's when an investor sells an asset at a loss, in order to pay less taxes when he sells an asset at a profit. The way this works is that the U.S. tax code allows individuals to use an investment loss to offset capital gains taxes on profit making asset sales.

The process is also commonly called "harvesting capital losses", because it often involves the purposeful selling of a losing investment for the explicit reason to gain a tax advantage.

Tax selling is perfectly legal, but there are a few restrictions:

  • Any assets sold for a loss must have been owned by the investor for at least 30 days prior to being sold.

  • The investor cannot purchase assets of a same type within 30 days of the assets being sold.

So, you can't buy shares in a small cap fund, sell them 29 days later at a loss to harvest the capital gain tax offset, and then buy shares in the small cap fund 15 days after you sold them. Violation of either of these restrictions is called a wash sale, and that is illegal. This 30 day limitation is often referred to as the 30-day wash sale rule.

Tax selling usually occurs in December, but keep an eye on the market as some are speculating there will be an increase in tax selling as the Bush tax cuts expire at the end of this year, and tax rates rise again.


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