Thursday, December 20, 2007

Winners and Losers

"You gotta know when to hold 'em,
Know when to fold 'em,
Know when to walk away,
And know when to run."
- Kenny Rogers ("The Gambler")

When reviewing one's run of luck - or lack thereof - at that poker table in the casino known as The Market, think about your taxes for a minute. If all your card-playing takes place in tax-deferred accounts like IRAs and 401ks, you can skip this post, because none of it will apply.

In a taxable investment account, you will have winners and losers. Some things you own will have done well and others not so well. A smart investor (since you are reading this, consider yourself a smart investor) will review his taxable account/s before the end of the calendar year with the idea of matching gains and losses. Depending on the extent of either, it is possible to sell stock (or bonds, or mutual funds, etc) at a profit and have no income tax liability because the (realized) gains can be offset by (realized) losses. The key here is "realized" which means the investment has been sold. Gains or losses existing solely on paper i.e., investments that are not sold, are "unrealized". Here's a simple example:

Jane has a taxable account with two stocks: Micro and Macro. She paid $100 for Micro and $110 for Macro. Micro is now worth $200 ($100 gain) and Macro is now worth $10 ($100 loss).

Jane could realize both the gain and the loss by selling the stocks and pay no taxes on the $100 gain in the Micro stock. The loss on the Macro stock offsets the gain in the Micro stock. In the real world of course, results don't necessarily work out so neatly as in our example, but the concept is the same. Gains and losses are reported on the IRS' Schedule D of Form 1040.

You should be able to easily determine if gain-loss matching will provide any benefit for you if you track your account/s at any of the on-line services or custodians. Your financial advisor should be able to provide the information if they include portfolio management in your service package.

For 2007 tax planning purposes, the sales must occur before the end of the calendar year. Nobody likes to fold 'em, but like the poker player, ya gotta know when it makes sense.

Questions? kimm@sweetwaterinv.com

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