Tax Education Center


Investors can only take advantage of tax smart trading strategies if they have accurately calculated cost basis of holdings and deciphered true realized and unrealized gains and losses. Adjustments for wash sales and corporate actions, such as stock splits, mergers, and spin-offs must be included in these calculations.

Review specific strategies to see if you can save money by Trading Tax Smart.

Realize a Short-term loss before it becomes Long-term
Realize gains tax-free if you have net losses greater than $3,000
Sell partial positions using Specific ID
Be aware of Mutual Fund distributions before purchasing a fund
Adjusting the Cost Basis of L-T Investments
Know the wash sales rule

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Realize a Short-term loss before it becomes Long-term

Since the tax rate for S-T gains is significantly higher than that for L-T gains (up to 35% versus 5-15%), it's often wise to realize losses on lots before they become L-T holdings, thereby lowering tax exposure. In contrast, you should wait for a winning position to become a L-T holding to take advantage of the lower tax rate. The savings could be significant.

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Realize gains tax-free if you have net losses greater than $3,000

The IRS allows a $3,000 capital loss. Any investor with a capital loss greater than $3,000 can realize capital gains for the difference. Here are a few scenarios with some hard numbers. An investor has a net loss of $17,000 for the current year. That investor can realize $14,000 worth of unrealized gains without impacting current year taxes. Or, let’s say that you had purchased stocks during the year, but have not sold anything, resulting in a zero gain/loss. The IRS allows investors to recognize a $3,000 trading loss which, for the average investor in the 28% tax bracket, amounts to a savings of $840. Let's say the same investor has recognized gains of $10,000 for the year. By realizing losses of $13,000, they would save $3,640! But, obviously, to take advantage of this, investors must know their true net gains/losses BEFORE the end of the year.

As we all know, paying taxes in the future is better than paying them now. If you can, hold gainers until next year. That way you can defer taxes on that gain one full year. Gifting a stock? Always gift stock lots with lower cost basis and short-term if possible and keep the higher cost, longer-term lots. This will save you real tax dollars in the long run.

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Sell partial positions using Specific ID

Many investors still fail to maximize the benefits by selling specific lots. Keeping track of your stock purchases at the lot level allows you to direct your broker to sell share lots that will be the most advantageous from a tax standpoint (instead of the default method FIFO (First-In, First-Out)). In most instances you will be selling those shares with the highest unit cost, thereby minimizing your gains and your tax burden. Even mutual funds can be sold using FIFO, Specific ID or Average Cost. You should choose which is most beneficial to your tax bill.

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Be aware of Mutual Fund distributions before purchasing a fund

Two other sell methodologies that are only applicable for Mutual Funds are Single Category Average Cost and Multiple Category Average Cost. Using the Single Category method you add up the cost of all your shares and divide that by the number of shares. This is the cost per share used to calculate a gain or loss.

With the Multiple Cost method, investors need to average the cost of all their long-term shares and their short-term shares separately. When selling shares an investor needs to identify whether they are selling long or short-term shares and use the appropriate cost calculation.

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Adjusting the Cost Basis of L-T Investments

This is an important tactic to remember in a volatile market. Investors often hold securities that they believe will perform well long-term, but currently hold a short-term loss. Doubling up your position in that security at the lower cost, and waiting more than 30 days to sell the original lot, can effectively lower your cost basis without incurring a wash sale. For example, let's say you bought 100 shares of Amazon at $80. It's now trading in the $40's. You may think it's a good long-term investment, but at $40 you are out of the money. You could sell and take the loss, but you'd have to wait 30 days to get back in or you would incur a wash sale. In those 30 days Amazon could rise and you would be left behind. So, instead of selling, you buy another 100 shares at $40. After 30 days your sell the first lot, realizing a large loss which lowers your tax liability, and you now own Amazon at a much smaller cost basis.

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Know the wash sales rule

If you are active in a particular stock, it is imperative that you monitor your wash sales period before you re-purchase the stock. Investors need to be aware of the date they can repurchase a security when that security had been sold for a loss. Investors may find themselves not being able to realize significant losses due to wash sales. Proactively tracking wash sales will prevent you from purchasing the stock in a wash sale period. Nothing would be more frustrating than selling stock at a loss to offset your tax bill only to find out after Jan 1 that a wash sale disallowed the loss.

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