When many of us look at our portfolios, we see virtually nothing but losers. Some folks have portfolios so far under water that it takes scuba equipment to check out their positions.

But just because your losers outweigh your gainers doesn't mean you can't ease some of the pain before the end of the year. There are some moves you can make that might not only spruce up your tax bottom line, but might also help you make critical decisions about the stocks, bonds, and mutual funds that you hold. So let's take a look at some of things that you can do to take a bicuspid out of your tax bite this year.

Bail!
If your portfolio is underwater, don't forget to bail (that is, bail out of those stocks that you no longer find attractive or appropriate) and take your tax losses. You can take up to $3,000 in capital losses (either long- or short-term) against your other income. If you're in the 27% bracket, selling enough loser shares to generate a $3,000 loss will save you about $810 in taxes. And that savings will be even greater if your state tax laws also allow such a deduction.

Net!
Perhaps your portfolio actually does include some appreciated shares that you are no longer interested in holding. You can use capital losses to offset those capital gains, and thus reduce your tax bill. For example, say that you sell shares for a $7,000 gain. That will allow you to use $10,000 in losses to offset the $7,000 gain, and then take the remaining $3,000 in losses against your other income.

Also remember that capital gains might come from sources other than sales of stock. It's possible that you'll be receiving a long-term capital gain distribution from your mutual funds. You might have sold an investment or rental property at a profit. You might have even made a profit on a second home that you sold. Those gains can be offset by losers that you sell in your portfolio.

Identify!
For tax purposes, the general rule is the shares you purchase first are the ones that you sell first (known more commonly as "first in, first out," or FIFO). But if you take the appropriate steps, you can specifically identify the shares that you sell when selling less than your entire holding in a stock. That allows you much greater control over the loss (or perhaps gain) that you'll realize on the sale, regardless of whether it's short- or long-term.

Convert!
Generally, you want your losers to be short-term, and your winners to be long-term. That might not mean much if everything you're selling is at a loss. But if you're looking at a net gain, try to do whatever you can to make that final net gain long-term in order to secure your preferred tax rate on long-term capital gains. You might want to convert some long-term losses into short-term losses in order to keep your long-term gains intact. So make sure to pay close attention to how you "net" your stock sales. (For more information, read Netting Out Capital Gains and Losses.)

Swap!
This technique works especially well with mutual funds. Say you own mutual fund shares in the Able Value Fund, which have decreased significantly since you purchased them. You'd like to stay with a value fund, but you're not married to the Able fund family. How about swapping those shares for shares in the Baker Value Fund? You'll sell your Able shares for your tax loss, and immediately buy shares in the Baker Value Fund. So while you're still a value fund participant, you've swapped fund companies and have generated a tax loss for the end of the year. This technique also works with individual bonds and bond funds.

Wash!
A similar technique that you can use for stocks is to sell you loser shares in Chip Company A, take the tax loss, and turn around and purchase shares in Chip Company B. You like the chip sector from a long-term or value standpoint, and don't want to completely get out of the industry. This technique will generate you the tax loss you desire, but allow you to remain in the chips (so to speak).

How about simply selling Chip Company A and turning right around and re-purchasing that same stock? Well, if you do that, you'll run afoul of the dreaded wash sale rules, and your loss will be ignored for tax purposes. Similar mutual funds, or even stocks in the same industry, are not considered "similar" for wash sale purposes, so you can make these moves without fear of Uncle Sam. But when your repurchased shares are virtually the same as what you sold, the wash sale rules will kick in and ruin your day.

Dump!
Do you have shares in your portfolio that have been de-listed? They might be technically "worthless" in the eyes of the IRS, and you might be able to take a worthless-stock loss deduction without even selling anything. That might help you rid your portfolio of these dogs without even touching any of your other holdings.

But the term "worthless," in the eyes of the IRS, has a bunch of technical components tied to it. Simply because the shares are de-listed or even if the company is in bankruptcy doesn't necessarily mean that the company is eligible for the worthless-stock deduction. But there are ways that you can still rid yourself of this junk by selling it to an unrelated party, making the sale complete, deducting the loss, and not having to worry if the junk is considered worthless in the eyes of the IRS. (To find out more, read Worthless Stock.)

These are just a few ideas to help you cut your taxes while pruning your portfolio. You might use one, two, or none of them -- that's up to you. We just want you to understand that you do have choices and alternatives when dealing with year-end tax planning issues even if you're dealing with a portfolio currently residing at the bottom of the sea.

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

November 15, 2002

Reprinted by permission. Disclaimer
© Copyright 2000-2002, The Motley Fool.
All rights reserved.