If you trade your tax bill with Jeff Bezos, does that mean you get his income too?
Actually, a tax swap doesn't refer to trading tax liabilities with someone else. Instead, it's a maneuver meant to take advantage of a capital loss, even though you want to maintain the loss-inducing investment.
If you take a loss on an investment, you can deduct the loss on your taxes (after all, you have to pay taxes on capital gains, so why shouldn't you deduct the losses?). Unfortunately, to take the loss, you actually have to, uh...take the loss. In other words, you have to sell the investment and book the loss, in order to deduct it from your taxes. A paper loss doesn't count.
So a tax swap involves selling the investment that has the loss, then buying a new investment that's pretty similar (though it can't be exactly the same; the government is onto that trick).
You own shares in a major (legal) drug maker that have fallen in the past few months. You are now $2,000 underwater on the investment, and want to deduct the losses on your taxes. In order to achieve this goal, you sell the shares and lock in the loss. Then you take your capital and buy a drug-maker ETF, which happens to have the stock you just sold as its highest-weighted component.
You didn't sell and repurchase the same stock. You bought a different vehicle with similar exposure. You still have an investment in the sector you had before...plus, now you've got that $2,000 tax deduction.
Related or Semi-related Video
Finance: What is Tax Loss Carry-Forward?328 Views
finance a la shmoop what is a tax loss carry forward
all right well feel bad about losing money in your business last year
well this law will help make you feel a whole lot better you had been going [guy sinking in bath]
along swimmingly making ten million bucks a year in your hot tub pimp out
biz where you are the premier provider of turbo Jets neon lights spa caddies [fancy hot tub]
massaging floor inserts and literal wet bars but then Kanye launched a competing [alcoholic beverages]
business called hot and wet by Kanye and the next year well you lost six million [Hot and Wet by Kanye building]
bucks well on your 10 million of taxable profits in a year you had been paying 30
percent tax or 3 million bucks in taxes to show net income or earnings of 7
million dollars well you lost 6 million dollars last year so you paid no tax and
no the government doesn't rebate you 30% in taxes like they don't write you a
check for 30% of 6 million or 1.8 million years that you lose money
running your business but they do allow you to carry forward that loss into the
next year or the next or the next usually up to 7 years total in most
cases so that tax loss of 6 million bucks then comes in handy the following
year when Kanye's hot tubs are found to be administering second-degree burns to [Hot and Wet news paper]
its buyers and you once again make 10 million dollars in taxable profits only
this time you have 6 million dollars of tax loss carry forward that gets first
subtracted from the 10 million before you have to even think about taxes so in
this case you pay taxes on just 4 million dollars or 30% of 4 million or
just 1.2 million in taxes to net 2.8 million in net income essentially the
government splits your losses and lets you take the taxable part of losses into
the future so that the lows are not so low and well as far as Kanye is
concerned the highs are not so high [Kanye in court]
Up Next
What is a tax deduction? Tax deductions decrease the amount of taxable income reported so that less tax is owed. For everyday civilians, these dedu...
Tax basis is your cost for assessing how much you owe in taxes, and is determined by multiplying your gains by your tax rate.