And other shrewd year-end tax moves

This has been a year of losses for most taxpayers… stocks have seen multiyear lows… home values have plunged. But there are ways to use losses to capture valuable tax benefits. While you wait for the market to turn around, take these steps before year-end…


If you hold stocks, bonds or fund shares in a taxable account, those securities now may trade at lower prices than the amounts you paid for them. What to do: Sell some of them now to realize a “capital loss” for tax purposes.

Here’s how this can help you. When you prepare your 2008 tax return, you’ll tabulate your realized capital gains (from assets you sold at a profit) and losses for the year. If you have more losses than gains, you’ll have a net loss, meaning that no capital gains tax will be due. What’s more, up to $3,000 of your net capital losses can be deducted to offset your salary and other ordinary income each year, further reducing your tax.

Excess losses can be carried forward to future years. These losses can offset gains that you take, as well as up to $3,000 of other income each year.

Strategy: After taking a capital loss, immediately buy a similar but not identical security or fund. (If you buy something “identical” within 30 days, the capital loss won’t count, because of the wash sale rule, but if you buy something similar, the loss will count.)

Example: You sell three health-care stocks for capital losses. Then you reinvest in an exchange-traded fund (ETF) that tracks a health-care index, such as Vanguard Health Care ETF (VHT). You’ll have your capital losses — and the tax benefits they provide — yet you’ll still be in a position to gain if health-care stocks rebound.

Also, when you reinvest in a similar security, the makeup of your portfolio won’t substantially change and you’ll have the same exposure to market risk.


Mutual fund investors may receive capital gains distributions from their funds in late 2008. Those distributions will be taxable even if your fund shares lost value in 2008.

Why this happens: Many investors bailed out of stock mutual funds when the stock market tanked. To pay these investors, funds had to sell their holdings. If a mutual fund winds up its year with a net profit on those sales, that profit has to be passed through to its investors. These investors, in turn, owe tax on the distributions (assuming that the fund shares are held in a taxable account).

Strategy: If you plan to sell mutual fund shares for a capital loss, complete the sale before the “record date” of the fund’s distribution. That date will be posted on the fund’s Web site. Selling before the distribution allows you to avoid the taxable gains.

After selling a mutual fund at a loss, you can invest in a similar mutual fund without jeopardizing your taxable loss, as explained above. You might sell one large-cap growth fund and buy another large-cap growth fund.

However, if you reinvest too soon, you might pick up the taxable distribution from the new mutual fund. Instead, hold the money in an interest-bearing account until after the new mutual fund makes its capital gains distribution.


If your modified adjusted gross income (MAGI) is less than $100,000 in 2008 (not counting the conversion), you can convert all or part of a traditional IRA to a Roth IRA.

Advantage: After five years and after age 59½, all withdrawals from a Roth IRA are tax-free.

The sagging stock market helps with conversions. You pay tax when you convert a traditional IRA to a Roth IRA. The less valuable your traditional IRA at the time you convert it, the less you’ll owe in tax.

Example: Paul had $100,000 in his traditional IRA in early 2008. All of the money in the account came from tax-deductible contributions.

If Paul had converted his entire IRA at that time, it would have counted as $100,000 of additional taxable income for 2008. In his 28% tax bracket, Paul would have owed $28,000 in tax on the conversion.

Better deal: Suppose that Paul didn’t convert his IRA and that it now is worth only $60,000 because the market has dropped. A Roth IRA conversion now would cost him only $16,800 in tax (28% of $60,000).

Added advantage: All Roth IRA conversions in 2008 get a January 1, 2008, starting date for purposes of the five-year requirement mentioned above. Thus, Paul will meet the five-year test for tax-free income on January 1, 2013, just a little more than four years from now.

Loophole: What if Paul’s IRA continues to lose value after he converts it to a Roth IRA? He can “recharacterize” (undo) a 2008 conversion at any time up to October 15, 2009, and retrieve any tax already paid on the conversion.

After waiting more than 30 days, he can reconvert the account to a Roth IRA and pay less tax if the account’s value is still depressed. That will be a 2009 transaction if the reconversion occurs before December 31, 2009.


Real estate has lost value, too.

Strategy: Lock in today’s low value for estate tax purposes. How: Sell your principal residence or vacation home to your children.

If housing values rebound in the future, the growth (and future income taxes, if any) will belong to your children, the new owners — and it will be out of your estate.

One approach is to use a self-canceling installment note (SCIN) to sell property to your children. A SCIN is an installment sale that is stretched out over more than one year. If you die before all of the payments have been made, the outstanding payments will be canceled. The value of unpaid installments won’t be included in your taxable estate.

Requirements: Your children, who will benefit if any outstanding payments are canceled, must pay more with an SCIN than they would with a regular installment sale, one that is not self-canceling. They might pay a higher purchase price or a higher interest rate than the current market would dictate. This is determined by the judgment of the sellers.

Advantage: You can live in or use the house after the sale as long as a fair rent is paid to the new owners — your children. Such payments will remove still more wealth from your taxable estate.

It is true that any debt forgiveness resulting from the SCIN will result in a taxable gain. However, that gain might be taxed at the favorable long-term capital gains rate of 15%. Talk with a knowledgeable tax adviser about your specific situation.