This week Gail doles out advice on taking a loss on a stock sale and distributions of 401k savings.

Hi, Gail-
Back in May I bought stock (200 shares @ $65.75) in an energy-related company. Seemed like a smart thing to do at the time since oil prices were only going up. Since then, however, they’ve come down quite a bit. Now the stock’s selling for around $58/share. I happen to believe that oil prices have got to head higher again, after all, there’s only a limited amount, so I think this stock will eventually take off if I’m patient.

Can I sell my shares to get the tax write-off for this year and buy it back after the first of next year?

Thanks,
Bob

Dear Bob,
The write-off on a loss on an investment has nothing to do with the years in which the purchase and sale occur. Instead, under the “wash sale” rule, it depends upon the number of days you wait before repurchasing the stock, bond, mutual fund, etc.

The basic rule is that you cannot deduct a loss within 30 days before or after the sale if you buy the same security or one that is “substantially identical.” Doing so “washes out” the deduction for the loss.

For instance, if you sold your stock on the last trading day of this year — December 29 — you would have to wait until January 29, 2007 (weekends do count) to buy it again if you wanted to deduct the loss on your 2006 tax return.

The concern, of course, is that the stock price will increase during this period and you’ll miss out. Buying an option on the stock won’t solve the dilemma because it is considered “substantially identical.”

Surprisingly, according to IRS Publication 550 (www.irs.gov) “bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation.” So these might be an alternative.

However, the operative phrase is “not ordinarily.” There are several exceptions. For example, if the bonds or preferred stock can be converted into common stock they could be deemed “substantially identical” because their price would have a tendency to move in the same direction as the underlying common shares.

If you think that the energy sector in general is likely to rebound, then one strategy would be to buy shares in a different oil-related company during the 30-day period. You could purchase these immediately after selling your current shares because, by definition, stock in two different companies is not “identical.”

This strategy also works well with mutual funds. Say you think small cap growth stocks are poised to take off. Problem is, the fund you own is currently worth less than you originally paid. You could sell it and immediately deploy the proceeds in the small cap growth fund offered by another firm. There is no wash sale issue because the two funds will not be managed the same way, own the same stocks, etc.

Unfortunately, things get a bit murky when it comes to index funds. For instance, I would argue that not all S&P 500 funds are alike. Sure, they own most of the same stocks, but when you get down to the smallest 50 or so names, they might own different percentages of each. The IRS hasn’t definitively answered this, either, so be careful.

It’s important to understand that if you don’t wait 30 days to repurchase the security your loss isn’t “lost.” It is added to your cost basis in the new shares, which reduces the gain you’ll have when you eventually sell them. In addition, the date you sold your original shares becomes the first day of the holding period for the new shares.

Hope this clears things up,
Gail

Dear Gail-
How are 401(k) savings distributed? Can a person select monthly pay out or lump sum?

Thanks,
Dale

Dear Dale,
While federal law spells out the broad rules under which company-sponsored retirement plans operate, there are areas in which an employer has significant leeway.

Your options for receiving distributions from an employer’s retirement plan are spelled out in the “Summary Plan Description” (SPD). This document explains out your rights and responsibilities as a participant in your company’s 401(k). You should have been given a copy of it when you became eligible to join the plan. Here is where you will find your answer.

You have a right to an updated copy of the SPD. Typically, you would request this from your human resources department.

Hope this helps,
Gail

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