Are there tax advantages to be gained when stock that you own decreases in value? The answer is yes, at least to some extent.
Here are some planning considerations:
Losses can only be deducted when you sell the stock at a loss. The reduction in value on stock that you continue to hold is not deductible. So if your stocks go in the tank but you do not sell them, you don’t get a deduction.
If you sold stock at a gain earlier in the year, you can sell other stock at a loss later in the year to eat up the gain. On your tax return, stock sold at a gain is netted against stock sold for a loss, to arrive at your net gain or loss for the year.
The tax code is not overly generous when it comes to deducting losses on investments. The loss deduction is limited to $3,000 of the net loss per year. Losses in excess of $3,000 can be carried forward to future years.
Beware of “wash sales.” A wash sale occurs when you sell stock at a loss and then buy the same stock within 30 days before or after the sale. (Example: you sell Stock A at a loss on August 1 and then re-purchase Stock A on August 15. This is a wash sale and the August 1 loss is not currently deductible but instead adjusts the basis of the stock you purchased on August 15.)
It is important to know your basis in the stock. For stock you purchased, your basis is your purchase price. The basis of inherited stock is generally the stock’s fair-market value on the date of death of the person you inherited the stock from. If you receive stock as a gift, you generally take on the basis of the person who gave you the stock.
Here is an example of the above concepts:
You bought stock several years ago for $750. Earlier this year, the value of the stock rose to $1,000. Then the market crashed and the stock dropped to $500, at which time you sold it. Your deductible loss is $250 ($500 sale price minus $750 basis).
In the above example, note that the fact that the stock rose in value to $1,000 at one time is irrelevant for tax purposes. The only thing that matters for tax purposes is your basis and the sale price.