2008 will certainly be a memorable year for the stock market.  Aside from the scandals and bailouts, bankruptcies and failures, average return is on pace to be one of the lowest in history.  This last fact means that many portfolios have declined significantly in value.  As a result, many people have unrealized losses sitting on the books.  Selling some positions to realize a loss could have favorable tax consequences while maintaining most of the upside potential for future gains.

In general, capital losses up to $3000 can be used to offset income each year.  Losses greater than $3000 can be carried over to future years.    Selling enough stock to book a $3000 loss will maximize the amount of income that can be offset this year.  The wash sale rule precludes this loss from applying if the same (of substantially similar) security is bought within 30 days to replace the one you sold.  To maintain upside potential you can either wait 31 days before repurchasing or instead by a different stock that is highly correlated to the one you sold.

Let’s say you have $7,000 worth of Google stock that originally cost you $10,000.  If you sold it before the end of the year, you’d have a $3,000 loss that could be used to offset income.  Waiting 31 days before repurchasing Google stock would be fine if the stock stayed flat or decreased in value, but would be a missed opportunity if the stock goes up during that time.  So you might instead buy something with the proceeds from the Google sale that trades like Google to catch any price movement. Here’s a chart showing Google, Apple, Microsoft, and the S&P500 Spider.  I’m not suggesting that any of these alternatives are perfect replacement for Google, just that their prices generally track similarly to Google.  You could either hold these alternatives for 31 days and then switch back to Google, or keep them as an alternative investment.

If you expect rising prices in your holdings for the next few years, you might even want to book more than $3000 in losses this year to apply in future years. By realizing losses and shifting to a security with similar price movement you may be able to realize a profit despite having a capital loss.

Every situation is different, so be sure to consult with a certified financial planner, accountant, or tax attorney before implementing any of the ideas on this site.