There are many things that I am not. Among them is stock analyst, but that doesn't prevent me from making weekly stock selections and thinking in the shoes of those that have a basis for spouting opinions. Of course, after a while you do begin to realize that there is some value to a formal education and in limiting your focus to what you know. Perhaps even leaving it to the professionals.
I haven't really learned those lessons yet.
Every year in the middle of December I sit down to see if there are any strategic tax losses to offset trading gains. That is a gift in the tax code and just about the only thing that makes taking a trading loss palatable for me. The fact that it is so difficult to take such losses is probably the root cause of my refusal to follow the Bernard Baruch rule concerning cutting losses.
This year is no different, but the thought process is a bit more involved because of changing capital gains tax rates. Although the final details may not yet be set, be prepared to pay more. Of course, the corollary is that tax losses may be worth more in the coming year.
There has been much talk recently about tax related selling strategies that are exactly the opposite of previous strategies that were based on accelerating deductions and deferring income. Now with a higher tax rate on capital gains likely in 2013, there may be reason to defer tax losses by waiting until 2013 to sell, while cashing out winners in 2012.
When it comes to closing uncovered positions that may be showing substantial gains, I have never used tax policy as a guide. I've experienced and heard of too many instances in which paper profits eroded as awaiting to see a short term gain become a more favorably taxed long term gain. However, waiting an additional day for 2013 to be ushered in may make sense given the difference in tax rates.
However, I have regularly used tax policy to cushion the impact of losses. The question is whether it's worth flipping the usual strategy around this year because of the new tax rates.
Assuming that you are in the highest Federal tax brackets in 2012 and 2013, the short term rates are 35 and 39.5% respectively. As always, your losses are limited to $3,000 in excess of your reported gains, with the ability to carry over additional losses to subsequent tax years.
In a nutshell, the extra cost of taxes is about 11.4%. What each person has to decide is whether 11.4% is too great of a hurdle to beat. In other words, if you wait until January 2, 2013 to sell your losers in order to get the 39.6% rate, you will have to wait until sometime in 2014 to see that benefit in the form of a refund or paying less in taxes at filing time. Compare that to having the money in hand a year earlier by virtue of taking the losses in 2012.
Can you get enough value and benefit from the tax credit now to offset the one year's wait otherwise? Add to that the reality that if you are like me and sell options, you will have substantial & realized gains in direct proportion to the size of your portfolio and that must be reported this year. Of course, that then will require tax payments in just a few short months, while any offsetting tax losses, if deferred until 2013, will then be delayed by a year.
The more gains that you have had in 2012 the more likely that you will want to offset whatever you can sooner rather than later. That's especially true if you come to realize that you cannot with any degree of certainty predict what your capital gains status will be in 2013. Even if you outperform the market, you may still end the coming year as a net loser. Remember 2008?
So not only is deferring a sale potentially subject to time erosion, but you are also introducing uncertainty and due to the limitation on how much can be taken as a tax loss, may be pushing tax advantages from losses many years into the future if next year is a particularly bad one for your portfolio.
Bottom line? Ask your tax advisor, but do so soon. Remember, I only play a professional in a virtual world.
As the last full week of trading in 2012 is soon upon us, I'm busily thinking of how best to take advantage of the gift provided by the tax code that rewards you for your trading stupidity. No matter how hard I may try, there is tangible evidence of such stupidity year in and out.
This year is no different.
Fortunately, 2012 was a very good year, but of course that means taxes. Because I am looking at significant capital gains for 2012, I have no interest in playing the game that many are suggesting and deferring losses until 2012, in order to potentially take advantage of a different tax structure. Hopefully, you're in the same situation, as I've had other years when the bottom line in Schedule D showed that I'd be carrying losses over. Not a good feeling. I'd much rather be searching for coerced tax related sales than wondering how many years it would take to use up the allowed losses.
All I know is that I have a tax bill due April 2013 and the alternative to declaring losses in 2012 is waiting until 2014 to derive any benefit, if indeed there is the need to offset gains in 2013. I'd like to think that next year will be as good as this past year, but I'd be a fool to start spending next year's profits in anticipation of a sure thing.
At the moment, the stocks that I've identified for potential strategic tax loss sales are my entire positions in Groupon (NASDAQ:GRPN) and Hewlett Packard HPQ). What was I thinking? To my credit, at least I never sought to add shares in those losers, as I normally do, as they were going further downward. In addition, I'll probably be selling a portion of my holdings in ProShares UltraShort Silver (NYSEARCA:ZSL) and Chesapeake Energy (NYSE:CHK), both reluctantly so. I will likely do the same with a portion of my Potash (POT) holdings, but there I don't have the same reluctance.
Where the reluctance stems is from the application of the Wash Sales Rule. Without being exhaustive in reviewing its application, the rule basically disallows the gift of tax related stock losses if within 30 days in either direction you buy new shares of the stock whose shares you sold at a loss. To complicate matters, the law actually includes the addition of "substantially identical stocks" during that 30 day period in an attempt to skirt around the intent of the tax code.
As an example from the "Option to Profit" trading alerts, if you owned the October 22, 2012 lot of Freeport McMoRan (NYSE:FCX) at about $40, you suffered along with me as its shares plunged on December 5, 2012 at the news that it was purchasing McMoRan Exploration (NYSE:MMR) and Plains Exploration (NYSE:PXP), both at healthy premiums. Although I do appreciate the end of the year tax gift, my first reflex is to do everything reasonable to prevent losses. For those subscribers that followed along and suspended rational thought processes, they would have subsequently purchased additional shares of Freeport McMoRan on December 5 and again on December 17th in order to help whittle down the unwarranted paper loss on the original shares. However, doing so, within 30 days of a potential tax loss related sale of the October 22 shares in order to meet the December 31st deadline for declaring a 2012 loss would have resulted in a violation of the Wash Sales Rule.
This applies even if the new shares were added in a tax deferred account. In fact, the buying of new shares in such an account is actually worse, as you are essentially banned from ever taking the loss, whereas if you happen to slip up or can't pass an opportunity in a taxable account, there are ways to adjust your cost basis in reflection of the disallowed loss.
So what does that mean?
For beginners, it means selling shares at a loss, something that I just hate to do. But importantly, it means resisting the urges to purchase additional shares in favorite stocks when it appears as if there may be an opportunity, as well as wondering if another stock might be considered to be "substantially identical." You don't want to leave that decision to someone reviewing your tax returns. Your logic may not be well aligned with his and your interests certainly won't be aligned.
That's why I mentioned ProShares UltraSilver and Chesapeake Energy as being sold, but with reluctance. Both have been excellent plays over the years and have been very profitable, albeit punctuated with periods of decreasing prices. In the case of the ProShares UltraShort Silver, that period of decreased price has been much longer than I ever expected, but to me, the charts look very, very promising for the future. In fact, after a very sustained period of higher silver prices, I think it will soon be time to re-initiate the self-hedging ProShares UltraShort Silver and UltraSilver trade (NYSEARCA:AGQ).
The problem is that I also want and need the losses, but fully expect those shares to start gaining value and perhaps very quickly. As much as I would hate to miss a rally, it's still not a sure thing, while the tax code is decidedly a sure thing, even as our elected officials hold it hostage. So, I may have been an idiot making certain trades, but I won't likely transfer that idiocy to tax related decisions. I will be taking that loss and keeping my fingers crossed for 30 days in anticipation of being able to jump right back in and catch a wave.
It most often doesn't work out that way, though. That's the real reason for the reluctance.
Another possible sales candidate is Intel (NASDAQ:INTC). It is one of the very few positions that I have that represents more than its fair share of my portfolio. The past 3 months haven't been kind to it, but it actually has outperformed the S&P 500 for the past month, so I'm still on the fence. The same can be said for Microsoft (NASDAQ:MSFT), but my paper trading losses in the current lots of Microsoft shares are far lower than for Intel, so I'm really not considering casting it off for its relatively meager tax advantages.
In addition, one has to wonder if Intel's and Microsoft's relative outperformance recently is a sign that the worst is over, both having been treated badly over the past few months as the personal computing story raised questions even among the faithful. Perhaps the roadblocks have been moved out of the way, more in the direction of Apple (NASDAQ:AAPL).
Groupon, Hewlett Packard, Intel and Microsoft? I think I see a common theme. Maybe the real message is that I should stay away from technology and social media and then I wouldn't have to think much about strategic tax losses. An accountant would probably add to that by saying that I should also stay away from accounting.
Although the optimistic among us can always hold out for the possibility of a strong rally between now and December 31st, I tend to look at the pragmatic issue as it is framed by the Wash Sales Rule. In this case, there may be advantage to not only making the sales of losing positions, but doing so before Christmas Day, perhaps even as early as this Friday.
The reason? The 30 day countdown doesn't get adjusted for weekends or holidays. Selling this Friday offers the benefit of capturing an additional two days from the weekend, added to the two market holidays on Christmas and New Years. That makes the 30 days go by faster as fewer trading days are in the mix. Only 18 trading days to be precise.
So, as hard as it is to do, you may soon have to be prepared to say goodbye to some bad friends earlier than envisioned, as well as some that had seen better times and may yet find their way back home.
Disclosure: I am long CHK, MSFT, ZSL, AGQ, POT, AGQ, HPQ, GRPN, FCX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.