I know what all you early birds did yesterday. You got your coffee, opened this web page, nibbled at your blueberry muffin, and then nibbled at the six stocks I mentioned. You clicked over to your deep discount broker, placing market orders at $8 commission each to buy them ‘at the open.’ You paid $25.55 for Citigroup and saw it close at $29.59, up 15.8% on the day. You paid $24.75 for EPN and saw it close at $27.95, up 12.9% on the day. You paid $39.10 for Merck at the open and watched it close at $42.60, up 8.9%. You paid $44.16 for Johnson & Johnson at the open and watched it close at $47.70, up 8% on the day. You paid $2.60 for CSPLF and watched it close at $2.86, up 10%. And – if the pink sheets are to believed – one of you actually bought 500 shares of BOREF mid-morning at $3, its only trade of the day. (Relatively speaking, quite a busy day for BOREF.)

I boast about this for the simple reason that I am never this lucky in my suggestions, so I’d better grab the chance to gloat – it could easily be my last.

I doubt yesterday’s 488-point rally will last, or that we’ve seen the bottom. But even if we’ve not, there’s so much cash sitting on the sidelines that you can expect to see violent spikes up, as yesterday, in what could be a generally difficult market.

But wasn’t it fun?

Lynn Smith: ‘Could you expand on the notion of tax selling? I, like everyone else, have some dogs in my portfolio. I’m familiar with the taxation of short- and long-term gains, but not so for losses. Is the treatment different for short- versus long-term losses? Losses can offset ordinary income? If you have gains and losses in the same year, can you benefit from more than a $3,000 loss.’

☞ Your short-term losses offset your short-term gains. Your long-term losses offset your long-term gains. At which point, you could be left with a net short-term loss or a net short-term gain; and a net long-term loss or a net long-term gain.

If both are gains – short and long – then that’s the end of the story. You pay ordinary income tax on the net short-term gain and the favored capital gains rate on the net long-term gain.

If one is a gain and the other is a loss, the loss reduces the gain and you pay tax on what’s left of the gain . . . or, if the loss exceeds the gain, you pay no tax on the gain and can deduct up to $3,000 of the remaining loss against your ordinary income, carrying forward any excess loss to offset gains or income in future years.

Tax-selling is the art of selling your losers before the end of the year so you can ‘take the loss’ and lessen or wipe-out your taxable gains and, in a year like this, very likely have losses to spare to lower your taxable income. The wise man may sell losers even at irrationally low prices, to lock in the loss and save on taxes (while his equally wise brother may buy that very same loser at that very same irrationally low price, to take advantage of that irrationally low price). Let’s say you paid $50 for a stock you somehow now know for sure is worth $5 – but is selling for $2. You might well sell anyway, because the $45-a-share tax loss might be more valuable to you than the $3 by which the stock is trading under its fair value. But you might then wait 30 days and, if it’s still around $2, buy it back on the 31st day, because there’s something undeniably appealing about paying $2 for shares worth $5. (You have to wait the 30 days or the IRS will call your original sale a ‘wash’ and pretend that it never happened.) Or if you don’t want to wait the 30 days, you might buy some different stock, beaten down to equally irrational levels by tax selling. (Or you could double up on the stock now, wait 30 days, and sell the original shares for a loss on the 31st day.)

Because people procrastinate, there will be a lot of ‘selling at any price’ near the end of the year just to establish losses. Others will scoop up all the shares they can at a dime each (say), hoping they will rebound to $1 after the first of the year, once the tax-selling pressure is off. And this can happen. (More likely, from a dime the stock will fall to a nickel, then to two cents, then to oblivion.)

There are two risks in what I just told you. First, that I have popped the Botox in your brow. It was supposed to last 3 months – it was injected just this past Monday – and instead your briefly placid forehead looks like the furrows in a cornfield. (Or so I would imagine, having grown up in Manhattan.) You need examples, and instead I have adopted the style of the IRS instruction booklet.

The second risk is that I have misstated this in some way, or forgotten a twist. But if I have, I know I’ll wake up to several e-mails setting me straight, which I will dutifully post tomorrow.

 

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