Tax Loss Selling

It’s been a great year overall. You own a dozen stocks. Eleven of them are up nicely. One, however, is a “pig.” Down big. There’s a week left in the year before the taxman closeth his books, and gains and losses are calculated for tax purposes. Of the 12 stocks you own, one has gotten really pricey, now trading at 80 times earnings. It’s making you really nervous, as you know that, if they don't have awesome earnings every quarter, the stock will get cut in half. Or worse.

So you have 1,000 shares of Chap My Hide, a company that sells leather-scented chapstick. The stock is now at 80 bucks. 80 grand worth, which you bought 3 years ago for 10 grand...or 10 bucks a share. Huge $70k gain. Nice work. But you know that, if you sell it, since you live in a high-tax blue state, you’ll pay dearly (about 35% tax on the gain, or almost 25 grand in taxes, leaving you just 55 grand in cash after the sale). Luckily, you carefully read this definition, and you know about tax loss selling. In this case, you have a big fat pig.

Okay, another stock, a totally different outcome. You paid 50 grand for Scratch n’ Sniff Diapers, Inc. when you bought your 2,000 shares at 25 bucks each 2 years ago. And now, after SSD shockingly missed 3 quarters earnings estimates in a row, the stock is down to 3 bucks a share. Basically, just the $2 of cash per share the company holds, plus a dollar. The company has had to abandon its plans to expand into scratch n’ sniff dress socks, so this is a big blow. But, for some reason, you still believe in the company and want to buy the stock back some day.

However, you have way more than a month before this pig heals itself, if ever. If you bought it back sooner than a month after you sold it, you violated the Wash Sale Rule, which says that you cannot sell a stock and then buy it back within 30 days, claiming it as a loss with the IRS to pay lower taxes. So you’ve lost hope, and you’re ready to take your losses and lumps and just sell it. And that’s actually a good thing to do here.

With tax loss selling, you just sell your shares for 3 bucks each, booking a loss of 22 bucks a share times 2,000 shares. Or 44 grand in losses. That $44k directly offsets the gains that you had with Chap My Hide, so from the IRS’ perspective, you won’t pay taxes on the 70 grand of gains you made from the sale of CMH shares...you’ll subtract the 44 grand of pig losses from that 70 grand of gains, and pay taxes on gains of 70 minus 44, or 26 grand. Your blue state 35% tax still applies, but now it’s on a much smaller base, as you multiply 0.35 x $26,000, and you get about 9 grand in taxes. Much easier to digest than the $25k you were going to pay otherwise.

So yeah, that’s what happens when you’ve got a pig…that’s badly in need of a wash.