The ink had barely dried on my previous column (Chevron, Stone Energy Are Oil Stocks Worth Keeping) when my accountant’s annual tax package arrived in the mail. That got me thinking. I am, as I have often said, a long-term investor who is willing to wait patiently through market upheavals. But I’m also always on the prowl for reasonable ways to shave my tax bill.
After all, building wealth isn’t just about what you make. It’s about what you keep. And one way to keep more of my gains is to trigger capital losses on the losers. Such losses offset first capital gains and then ordinary income, up to $3,000 each year. If you have more losses than you can write off in any one year, you may roll them forward indefinitely until you use them up. If a future Congress hikes taxes on capital gains, those losses could become even more valuable, particularly for those of us who reside in high-tax states. (I live in California, which taxes capital gains as ordinary income, at rates as high as 13.3%.)
Most people start thinking about taking their losses near the end of the year. I think it’s smarter to take them when the opportunity presents itself. But realizing losses with individual stocks—particularly stocks that you think may rebound—is trickier than it appears because of Uncle Sam’s “wash sale” rule. In a nutshell, the IRS won’t let you claim a capital loss if you buy back the same (or a substantially identical) security within 30 days of the sale.
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Satisfying the IRS
The rule applies to all sorts of assets, including mutual funds. With funds, it’s a breeze to get around the wash sale rule. If, say, I’m down in a fund that tracks Standard & Poor’s 500-stock index, I could sell and replace it for 30 days with a fund that tracks the Wilshire 5000 index. Their returns might not be identical, but they’d be close.
Sidestepping the wash sale rule with individual stocks is tougher because my predict-o-meter always seems to go on the fritz when I try to foresee short-term price swings. The last thing I want is for a stock that I’m out of for tax reasons to skyrocket during the 30-day separation period.
One way of dealing with that potential development is to sell my loser and replace it with a similar stock in the same industry. But that’s not easy, either. For example, I’m sitting on a $4,000 loss in Nu Skin Enterprises (symbol NUS), a multilevel marketing company. You could argue that I could sell Nu Skin, buy Herbalife (HLF), another MLM firm, and, er, still keep some skin in the game. My rejoinder is that Herbalife is more about nutrition, and Nu Skin focuses on anti-aging products. Revenue and profit expectations, as well as the geographic location of the bulk of the companies’ customers, are too disparate for me to consider the shares an even exchange.
The one loser in my portfolio that offered the possibility of a comfortable swap was Stone Energy (SGY), a small domestic energy producer in which I was down $4,800. That’s because I could switch into one of several exchange-traded funds that emphasize oil-and-gas producers that are a lot like Stone. Selling Stone, which I did in early February, to get a diversified basket of similar stocks should certainly satisfy the tax man, and I’m confident that once oil prices begin their inevitable rebound, the ETF will capture most of the gains I would get from Stone. Meanwhile, the sale will cut my federal and state income taxes this year by up to $1,675.
I temporarily replaced Stone with SPDR Oil & Gas Exploration & Production ETF (XOP). It holds mostly small and midsize firms, and no stock represents more than 2% of its assets. I like that because when a fund heavily weights a few stocks, I’m tempted to research the top holdings. And that seemed like more work than taking this tax loss deserved.
