Stocks took a licking, but you can keep on ticking at tax time
Taking a beating on the stock market is bad enough; you don't need to take a beating from Uncle Sam at tax time, too. You may not have to.
Investors who took big losses since Oct. 19 are trying to figure out how to make the best of their losses next year when they prepare taxes. The first thing to remember is that there are losses, and then there are losses, says Neil Becourtney, tax supervisor in the New York office of Mann Judd Landau, an accounting firm.
If you bought a stock five years ago, watched it grow every year, and sold it on Oct. 19 or 20, you probably didn't lose any money, he says. ``This is a paper loss,'' Mr. Becourtney says. It simply means you didn't make as much as you would have had you sold a few days earlier. The market plunge may have wiped out a year's worth of gains, but you still received four years of profits. These are taxable gains, and the so-called losses have no tax consequences.
It is ``realized losses'' that make a difference on the tax form. If you sold a stock for less than you paid for it, that was a loss. The same thing applies to bonds, mutual funds, and real estate.
While those losses aren't much fun, the disappointment can be eased somewhat by writing off losses against any gains - if you had any gains this year. An investor can offset up to $3,000 of this year's capital gains with the same amount of losses, provided the investor has at least $3,000 of total taxable income.
``To the extent you had any gains, you can offset losses,'' says Richard J. Shapiro, national director of taxes at Oppenheim, Appel, Dixon & Co., accountants.
If there were no gains this year, just losses, all is not lost, Becourtney says. Though you can't deduct those losses this year, you will be able to offset them against any gains next year, the year after that, or as many years as you need. And if there were more than $3,000 in losses this year, you can carry the excess into following years.
``If there's a net loss of $12,000, a person will have $3,000 to use this year,'' Becourtney says. ``Then they'll have $9,000 of losses to carry forward to 1988. If they deduct $3,000 in 1988, they'll have $6,000 to carry forward to 1989.''
How long you held an investment before bailing out has no effect on losses, but it will make a difference if you had a gain. Any profits made on investments held six months or less are considered short-term gains for the 1987 tax year. Profits on investments held more than six months are considered long-term.
This is where the 1986 tax reform act comes in. This year, the maximum rate on short-term profits is 38.5 percent, while the maximum rate on long-term profits is 28 percent. Next year, the top rate for all gains - long or short - will be 28 percent for some upper-income taxpayers (up to $149,250 on a joint return), even for those upper-income people who may pay as much as 33 percent on ordinary income.
For many investors, this will lead to a strategy of trying to offset as many losses as possible against gains this year, since the deductions will be more beneficial with this year's higher tax rates.
Investors in the stock market aren't the only ones who had some rude shocks this year; the municipal bond market has taken two dives, though neither of the magnitude of the Oct. 19 stock plunge. Still, muni bond investors have taken some losses, which can also be partly eased by something called a bond swap, unless Congress changes the rules.
As interest rates go up and bond prices go down, it is possible to sell a municipal bond at a loss and buy a similar bond from a different municipality with a similar maturity date and interest rate. Because the bonds come from different towns, the Internal Revenue Service will not consider them substantially identical.
This way, you get the deduction for the current loss; later on you can get an offsetting capital gain when the new bond matures or is sold.
But last month, the House of Representatives passed a bill that could change this. Under this provision of a larger revenue-raising bill, if the new bond is purchased at a discount - say it's a $10,000 bond going for $8,000 - the taxpayer would have to pay taxes on a portion of the $2,000 discount every year. As written in the House bill, this would apply to both taxable corporate bonds and tax-free municipals.