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From a tax standpoint, dumping losing-money security prior a year end is not a bad idea.  The tax advantages of setting your gains against your losses can be enormous as long as you follow all the rules and implement a few tricks of the trade.
 
Tax-loss harvesting, also commonly known as tax selling, is one of the ways to avoid taxes on some of your portfolio gains. Tax-loss harvesting is the selling of securities, usually at year-end, to realize portfolio losses, which an investor can use to offset capital gains and therefore lower personal tax liability.


Tax Treatment of Gains

If you, like many others, own shares of a mutual fund, you are most likely subjected to some type of year-end payout.  This could be in the form of a dividend, interest payout, short-term capital gain or long-term capital gain.  Now, if the security giving you the payout is in a taxable account, then Uncle Sam will be sure to want a piece of the pie come tax time. 

For tax-reporting purposes, the short-term gains and losses (those made in one year or less) are first netted against each other for the tax year; then long-term gains and losses (those made in more than one year) are netted; and finally the remaining outcomes are combined together. 

In any given year, there is no limit on the amount of capital losses that can offset capital gains.  However, only a maximum of $3,000 net loss can be deducted from ordinary income; any excess loss may be carried forward into future tax years.  The carry-forward loss must maintain its definition as either a short- or long-term loss. If you and your spouse file separately, the maximum capital-loss deduction limit is $1,500 per spouse, not $3,000 each.

 
The Wash Sale

With the wash-sale rule, the IRS disallows a loss deduction from the sale of a security if a ‘substantially identical security' was purchased within 30 days before or after the sale.  The wash-sale period is actually 61 days, consisting of the 30 days before and the 30 days after the date of the sale. The wash-sale rule is designed to prevent investors from making trades for the sole purpose of avoiding taxes.

For example, if you bought 100 shares of Google on December 1 and then sold 100 shares of Google on December 15 at a loss, the loss deduction would not be allowed. Similarly, selling Google on December 15 and then buying it back on January 10 of the following year does not permit a deduction.

Selling an S&P 500 index fund and then immediately buying an S&P 500 index fund from a different company is a grey area.  Due to the IRS vagueness on wash sales and mutual-fund trading, you'll likely encounter no issues with the deductibility of a loss resulting from this type of transaction.  However, many tax professionals will advise to avoid the situation if possible.


Strategies

Here are some strategies and rules to keep in check when implementing tax-loss harvesting: 

•    If you want to stay in the asset class, you can purchase a similar but not substantially identical security immediately after the tax-loss sale of your original position.

•    If, after selling the security and realizing the capital loss, you still believe that the security is a keeper, wait the 31 days for the wash-sale period to elapse, and then repurchase the original security.

 

 

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