The bad news is that your investments went to hell in a handbasket last year. The good news -- at least at tax time -- is that these losses may provide you with plenty of deductions that can significantly reduce your income taxes. “Nobody wants losses, but as long as you have them you might as well make some use of them,” said Philip J. Holthouse, partner at the Santa Monica tax law and accounting firm of Holthouse Carlin & Van Trigt.
What can you do with investment losses? It depends on the type of loss and whether you have profits in a similar investment category. In some cases, losses can offset your taxable income. In other cases, no way. Investment losses fall into four buckets.
Capital losses -- These are the most common. These are the losses you might have generated from the sale of stocks, bonds and mutual funds in 2008.
If you held the security for more than a year, the capital loss would be classified as “long-term.” If you held it for even one day less, it’s a short-term loss. Why does it matter? If you have short-term gains, they’re taxed at your ordinary income tax rate. If you have long-term gains, they’re taxed at a maximum rate of 15%.
If you have more losses than profits -- as many people do for the 2008 tax year -- you can use the excess to offset up to $3,000 in ordinary income each year.
What to do when there are still losses left? Roll them forward into future years to offset gains and income then. One caveat: Paper losses don’t count. To claim a tax loss you have to have actually sold a security, not just been depressed by its diminished value on a brokerage statement. The one exception is for securities that have become worthless, Holthouse said. You can treat those as if they were sold for nothing at the end of the year as the tax law recognizes it is hard to actually sell something that has no value.
Collectible losses -- This is for collectors. Let’s say you got really into the Beanie Baby craze and spent $3,500 for “Chilly” the polar bear, which has been sitting inside a dusty glass case for the last 10 years. Now, Chilly and the rest of the Beanie crew are sporting $1 price tags at your neighborhood garage sale.
When you sell yours you have a “collectible loss” that amounts to the difference between what you paid for them and what they sold for today -- assuming that all those plush toys were purchased for investment, not to plop on your kid’s pillow.
Collectible losses can offset collectible gains -- such as the profit on the sale of your baseball card collection, which you accidentally accumulated for practically nothing when you were a 10-year-old sports fan. Now, if you sell your 1952 Mickey Mantle card for $9,000, instead of paying a 28% tax on the gain -- that’s the tax rate for collectible profits -- you get to subtract the net loss on the plush toys. You pay tax only on the difference.
If you’ve got leftover capital losses from the sale of securities, they can be used to offset your 28% collectible gains too.
Passive losses -- You bought real estate, thinking you’d fix up that rental home and sell it at a huge profit. But now you’re renting out the home and paying more to keep it up than you are getting in rent.
More bad news: Unless you can show you’re actively managing your properties, what you’ve got here is a passive activity loss, which is only deductible against passive activity gains.
On the bright side, these losses never expire. So, if you manage to pay down the mortgage and start to make a profit in 2025, you can use these built-up passive activity losses to wipe out your future gains.
What if you can show that you “actively participate” in managing and renting this real estate? Then you may be able to write off up to $25,000 in losses against ordinary income. If your adjusted gross income exceeds $100,000, however, you lose a portion of the write-off. It evaporates completely once modified AGI exceeds $150,000.
Personal losses -- If you sold your home at a loss, none of the loss is deductible. That’s because tax authorities think that you bought your home for personal use, not as an investment.
What happens if you sell that home at a profit? Well, then, tax authorities consider it an investment.
“It’s not a two-way street,” said Mark Luscombe, principal federal tax analyst with CCH Inc., a Riverwoods, Ill., publisher of tax information.
On the bright side, if you’ve lived in the home for at least two of the past five years, singles can exclude up to $250,000 of the gain and married couples can exclude $500,000 from income. But the rest would be taxed at capital gains rates -- unless, of course, you’ve got other capital losses to offset the gain.
Kathy Kristof is a personal-finance author and syndicated columnist.