BUSINESSWEEK ONLINE : NOVEMBER 13, 2000 ISSUE
BUSINESSWEEK INVESTOR Making the Best of Your Clunkers How to get the government to share the pain at tax time This year, Apple ( AAPL) fell far from the tree. So did a lot of other tech stocks. Dell ( DELL), Microsoft ( MSFT), Yahoo! ( YHOO), and Amazon.com ( AMZN) are all down more than 40% in 2000 (through Oct. 30). If you've owned the stocks over the multiyear run-up, you probably are still sitting on a pile of profits. If you bought them in the past year, you may be stuck with big losses. Don't just let those losses sit there. Harvest them. They can have value when you file your income taxes next April. You sell the stock, take the loss, and use the loss to offset other capital gains. Don't have other capital gains? You can write off up to $3,000 against ordinary income. If the losses are even greater, you can use the excess as deductions over the next seven years. ''You might as well let the government share your pain,'' says Ed Slott, a Rockville Center (N.Y.) tax adviser. Harvesting losses in the fourth quarter is a longtime Wall Street practice. But in the strong bull market of the last few years, there weren't this many losses to reap. And the big losers aren't all in technology and telecom. Nontech household names such as DuPont ( DD), Home Depot ( HD), McDonald's ( MCD), Procter & Gamble ( PG), and Wal-Mart Stores ( WMT) are all down more than 22%. Many of these stocks will no doubt blossom again, and you may still want to own them. But if you sell to take a tax loss, the Internal Revenue Service's ''wash-sale'' rule says you cannot buy them back for at least 31 days. That leaves you empty-handed for a month during which there could be a rally in the stock you're waiting to repurchase. Fortunately, you can work around the wash-sale rule. One approach is substitution. You realize the loss in one stock and replace it immediately with a similar one. So you sell DuPont and buy Dow Chemical ( DOW) to keep your hand in chemicals, or sell DaimlerChrysler ( DCX) and buy General Motors ( GM) to stay with autos. On the 31st day, you sell the substitute and buy the original holding. Finding a good substitute isn't easy. The key is understanding how much of a stock's performance is industry-driven and how much is unique to that particular stock. ''Substitution plays out in homogenous types of industries such as oil and health care,'' says Frank Morris, manager of the Delaware Tax-Efficient Equity Fund. ''It's a little harder to do in technology, given the complexity of the sector's businesses.'' An area of technology where substitutions work well is personal computers, because PCs are essentially commodities. ''Theoretically you could be selling your Apple, reaping your loss, and buying Gateway and Dell,'' says Morris. Performance at such companies is driven more by external factors such as chip pricing and PC demand than by anything unique to the companies. Chip stocks are also industry-driven, though less so than PCs. You can sub Advanced Micro Devices ( AMD), Intel ( INTC), and National Semiconductor ( NSM) for each other. Fund managers say some of the big telecom players are swappable. ''I've been selling WorldCom ( WCOM) and AT&T ( T) and buying Qwest Communications ( Q),'' says manager Terry Banet of J.P. Morgan Tax-Aware U.S. Equity Fund. ''I also swapped Lucent ( LU) for Nortel ( NT).'' But Banet sees the harvest as part of the portfolio review process as well. She's not planning to buy back Lucent Technologies because, she believes, Nortel Networks is a better company. Another way to finesse the wash-sale rule is ''doubling down.'' Suppose you own 200 shares of Dell on which you have an unrealized loss. Buy another 200 shares, wait 31 days, and sell the 200 shares you bought at the higher price. That way you don't lose your exposure to the stock for the month and you still get to reap the tax loss. Of course, if the stock tanks during the month, you may have more losses than you originally planned. SIMILAR CHANCES. Then there are Holding Company Depositary Receipts or HOLDRS. These are trusts issued by Merrill Lynch, which are similar to exchange-traded funds (ETFs). They may be extremely concentrated in just a few stocks in one industry. Some of the stocks in HOLDRS may match yours, but others are different enough to not trigger the wash-sale rule. You could sell America Online ( AOL) and Yahoo! and buy Internet HOLDRS Trust, which has a 49% weighting in these two stocks. B2B Internet HOLDRS has a 44% weighting in Ariba and 20% in Commerce One. Regular ETFs offer similar opportunities, but they tend to be less concentrated and less industry-specific. To take losses in Wal-Mart and Home Depot, you can substitute the Cyclical/Transportation Select Sector SPDR, which is 35% invested in those two stocks. ETFs and HOLDRS generally have lower expenses than mutual funds, and they don't usually make taxable distributions. You don't want to be waiting out the 31 days in a fund, and get hit with a taxable distribution in the interim. Some financial planners use other strategies. One is to sell a losing stock in a taxable account and buy the same stock back in an individual retirement account. Since an IRA is a separate legal entity held by a custodian on your behalf, you, the IRA beneficiary, aren't making the trade. The custodian, usually the brokerage firm, is doing it. Moreover, the IRS doesn't usually look at IRA holdings. ''No one is required to report transactions in an IRA,'' says Al Blomquist, a financial adviser in Franklin Lakes, N.J. ''And the government isn't required to audit them.'' But that doesn't mean that the IRS wouldn't disallow the tax deduction if you should be audited. Since the strategy hasn't been tested in the courts, more conservative planners steer clear of it. ''There is no proscription against the strategy in the law,'' says Beth Rodriguez, a wealth strategist at the private bank of J.P. Morgan. ''But would the IRS attack it if they found out? We think yes.'' Another gray-area strategy is having a relative purchase the losing stock after you sell it. According to tax analyst Mark Luscombe of CCH, a tax-law specialist, one spouse cannot sell to take a loss and the other repurchase it. That's because the IRS considers a married couple as a single entity. But it's O.K. if the repurchaser is a sibling or child, he says, as long as the child is over 14. Under that age, the tax status is an extension of the parents'. But here again there is some debate. While the wash-sale rule does not forbid such transactions, Section 267 of the tax code prohibits deducting a loss on assets that are sold to relatives, including siblings and children. The question is, if you sell a stock and your sibling buys it in the open market, can that be considered an indirect sale from one family member to another? To avoid this, the family member should wait a few days to buy back the stock, or make the purchase of slightly greater or fewer shares than the original holding. Whichever approach you take, the most important thing is to get it done. The 2000 harvest needs to be completed by Dec. 31, after which those tax-losses will be plowed under. By LEWIS BRAHAM _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Making the Best of Your Clunkers TABLE: Trading for Tax Losses INTERACT E-Mail to Business Week Online

Copyright 2000-2009, by The McGraw-Hill Companies Inc. All rights reserved. Terms of Use   Privacy Notice