With the stock market ending in the red for the second year in a row, Eugene Mahr of Newton plans to sell a losing investment - a tech stock - by Monday's year-end tax loss-selling deadline.
"I have a couple of thousand in losses. There's no reason I can't use it to offset some gains," said Mahr, 45, former vice president for an Internet start-up and former Polaroid marketing director who's now doing consulting work between positions.
Ken Depperman, 67, a retired coast guardsman on the South Shore, recently sold the remaining shares of his Fidelity Select Developing Communications fund, which is down more than 30 percent in 2001, after having sold some of it last year for a tax write-off.
And since November, Eugene S. Tarsky, a Norwood certified public accountant, has been busy with the 20 to 30 percent of his clients selling investments for tax losses. "This year, there's much more heightened interest in selling," said Tarsky, who says he'll be working long hours through New Year's Eve.
With the 1990s bull market fading into memory - and with the first back-to-back losing years in the stock market in decades fresh on people's minds - buying hot IPOs is out, and selling losers is in.
Like Mahr and Depperman, countless investors are unloading shares. And financial professionals are helping clients understand the intricacies so that they don't run afoul of the so-called wash-sale rule, which means the Internal Revenue Service disallows some or all of the loss for the year.
By selling losing investments, investors can offset capital gains from a stock or mutual fund - plus write off up to an additional $3,000 against ordinary income for the year - under US tax law. Any capital losses beyond that can be carried forward.
That means an investor who realizes losses equal to gains may not have to pay any capital gains tax. And that means an investor who has an additional $3,000 in losses to write off against ordinary income may save up to $825 in income tax, presuming a 27.5 percent tax bracket in 2001.
While these tax rules have been on the books for years, prompting an annual rush to sell in December, 2001 has a particular "now or never" feeling because of the widespread market losses and tax changes that will reduce future tax savings from selling losing investments.
For instance, with marginal tax brackets starting to drop next year, courtesy of the tax cut signed by President Bush, that same $3,000 in losses against ordinary income in 2002 would net only $780 in tax savings, compared to $825 in 2001, as the 27.5 percent bracket drops to 26 percent.
Some financial specialists think this December's sales volume will be lighter than in 2000 because so many investors took their lumps last year to offset capital gains earlier in 2000.
"Basically, you don't have those kinds of gains this year. We've had 18 months of a pretty nasty bear market," said Donald Cassidy, senior research analyst at Lipper, a mutual fund research firm, and author of "It's When You Sell That Counts."
Investors may not need to worry as much about taking losses against gains this year. Lipper estimates that overall, mutual funds will report about a 70 percent lower capital gains distribution in 2001, of $100 billion, compared with last year's $325 billion.
Some of those gains are within tax-deferred retirement accounts. For the 50 to 60 percent of the mutual fund business that's in tax- deferred retirement accounts, there is no tax advantage to selling a loser, according to Avi Nachmany, research director at New York- based mutual-fund research firm Strategic Insight.
But gains in taxable accounts may represent a double whammy: Investors will have to pay taxes, even if the mutual fund lost money for the year, unless they can offset the gains with losses. (Even if a fund lost money overall, it may have sold some of its stock holdings at a gain. Such gains must then be passed through to shareholders.)
One reason shareholders sitting on losses may be less likely to sell now, according to Cassidy, is investor psychology.
With the stock market going up the last couple of months, there's "renewed hope," he said. "People are saying, `Maybe if I hold on, this will work out after all.' "
But those who have studied investor behavior caution against holding on too long to try to break even or avoid admitting a mistake. Knowing when to sell, whether at a loss or a profit, is hard enough as it is, without emotions.
"I always think renewal of hope is probably a bad thing, an unfortunate thing. It makes you hang in there based more on hope than reality," said Cassidy, a proponent of having a selling strategy in place to minimize losses and take profits.
Whether it's false hope or plain old inertia, statistics from Strategic Insight indicate many investors sit tight and refrain from year-end tax-loss selling, even in years like 2000 and 2001.
"Every December, there's a slight pickup in trading activity in the fund business, partly related to year-end tax-loss selling," said Nachmany. Even then, he said, "less than 1 percent of equity assets switches out in December."
If you are considering taking your losses, don't let taxes alone drive your decision. You have to have an investment and asset allocation strategy in place, or you could always be selling losers without ever getting ahead.
You should also realize the intricacies, risks, and trading costs that come with pulling the plug. Selling for a loss can be so complicated that there are Web sites such as GainsKeeper.com, Morningstar.com, and TaxPlanet.com that offer advice on how to do it.
One big trap for investors selling their losers: the wash-sale rule.
The IRS will disallow all or some of a loss for the year if you buy a substantially identical investment within 30 days, either before or after you sell the losing shares. The IRS lets you adjust what's called the cost basis of the new shares, however, to benefit from that disallowed loss in the future.
There are ways around the trap, such as waiting 31 days before buying back the shares or doubling up 31 days ahead of time and then selling the original higher-cost shares.
But there are risks: In the first scenario, the price could skyrocket while you're on the sidelines. In the second, you could mistakenly sell your lower-cost holdings if you fail to tell your broker which specific shares you want dumped, or you could end up with twice the shares in a loser if you can't pull the trigger.
Retired coast guardsman Depperman thought he knew the ins and outs of the wash-sale rule when he sold part of his holdings in the Fidelity Select Developing Communications fund in late 2000.
But then he got a notice that about half of his approximately $6,000 loss that year would be disallowed, because the fund reinvested a huge capital gains distribution about a week after he sold some of his shares. "It never dawned on me," he said.
With the fund down another third this year, he sold his remaining shares in October. "I just decided to get rid of it."
For Mahr, who's selling a losing stock - Lucent Technologies - for tax purposes for the first time ever, the plan is to use the approximately $2,000 in losses to offset mutual-fund capital gains and otherwise minimize his family's tax bill.
He'll wait more than 30 days and perhaps buy the stock back at a lower price - currently $6, down from the $20 or so he paid - if he believes it's a good investment then.
Being able to take a tax loss "almost provides a rationale, if on an emotional level you can't bring yourself to sell a loser," he said. Mahr, a father of two, may be able to wipe out as much as $320 in capital gains taxes and reduce his and his wife's taxes by about another $100 by taking the loss on Lucent.
"Look at the cold hard facts," he said, "if you need something to hang your decision on."