by Larry Dresner

Created on: December 20, 2008

The Silver Lining To All This

Tax loss harvesting (for taxable accounts). This is the strategy where you sell investments that have sustained a loss and immediately purchase a similar investment. Selling the investment at a loss allows you three benefits: 1) to offset capital gains incurred during the current year; 2) to use any excess losses to offset ordinary income up to $3,000 per year; and 3) carry forward indefinitely, until used up, unused losses to offset realized gains in the future. Immediately purchasing a similar investment allows you to stay invested to participate when the markets rebound and you know they will. This is not a market timing strategy, but rather a way to reduce your taxes. You can't sell and immediately purchase the identical investment within thirty days.

It must be similar; otherwise the IRS will disallow the transaction. So if you're selling a large cap value mutual fund, purchase a similar large cap value fund from the same provider or a different mutual fund company. When purchasing a similar fund, it's important to watch out for imbedded capital gains in that new fund. These imbedded capital gains come from the mutual fund having to sell shares when other investors want to redeem their money. At the end of the year, the mutual fund has to declare the capital gains incurred. Buying a fund with large imbedded capital gains is like jumping out of the frying pan and into the fire, because now you'll be stuck paying tax on those imbedded gains just what you're trying to avoid by using this loss harvesting strategy. Mutual funds list this information, but you have to dig deep into the prospectus or call the mutual fund company. Although this all may seem somewhat daunting, it's a great, though infrequently used, technique to reduce your taxes.

Converting to a Roth IRA Since most IRA account balances are lower than they were in December of 2007, you would be paying less tax now if you convert. The income limit for conversions is $100,000 of modified adjusted gross income for both joint filers and singles. If you qualify to convert, you probably should. Besides allowing tax-free and penalty-free withdrawals of contributions, the Roth IRA enables most savers to amass a greater nest egg because withdrawals from earnings during retirement are tax-free (as long as you are over 59 1/2 and have had the account for at least five years). Starting in 2010, and continuing in future years, that limit disappears. Regardless of your income, you'll

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