Winning With Losers

With the Bush-era tax cuts -- including preferential rates on capital gains and dividends -- in place for another year, many investors can move forward with the traditional year-end harvest: By selling losing investments that can sop up investment gains, you can lock in some tax-free profits. Whether Congress will extend those tax cuts beyond 2012, when they are due to expire, is anyone's guess.

SEE ALSO: 12 Year-End Tax Moves to Make Now

"Investment decisions should never be driven entirely by tax issues, but there are instances where you can make sound investment decisions that will decrease your tax liability," says Timothy Steffen, Director of Financial Planning for Robert W. Baird & Co., an international wealth management firm.

If you hold an asset for at least a year and a day and sell it at a profit, it's a long-term capital gain, currently taxed at a favorable top rate of 15%. (And if you're in the 10% or 15% income-tax bracket this year, you'll pay zero tax on your 2011 capital gains.). Sell that same asset at a loss and it's a long-term capital loss, which can offset capital gains dollar for dollar. So review your portfolio for dogs you might want to dump and winners you might want to cash in before year-end.

If you sell some assets at a loss, you first must use your capital losses to offset capital gains, if any. After that, you can use up to $3,000 of excess losses to offset other kinds of income, such as your salary or IRA distributions.

Ironically, that means excess losses are extra valuable. Instead of offsetting long-term gains that would be taxed at a maximum 15% this year, for example, they can offset income in your top tax bracket -- as high as 35%. Excess losses can be carried over to the following year. (Don't forget to check last year's tax return to see whether you reported excess losses that can be carried forward to 2011.)

One word of caution: This strategy applies only to your taxable investment accounts, not your tax-deferred retirement accounts, such as IRAs and 401(k) plans.