Tax Loss Harvesting To Reduce Income Taxes

September 22, 2008

Recently I posted about capital gains and losses and the tax implications. Understanding how the IRS views short-term and long-term capital gains and losses is important for minimizing taxes. To minimize taxes on investment income it’s important to know when a capital gain becomes a long-term gain instead of a short-term gain. Short-term gains are taxed at normal income tax rates, whereas long-term rates are taxed at a much lower rate. Another method of reducing taxes on investment income is to harvest your losses.

Tax Loss Harvesting

Tax loss harvesting is the art of using capital losses to offset capital gains for tax purposes. Harvesting is most often done to reduce the impact of taxes on short-term capital gains, which are taxed at higher rates than long-term capital gains. Not only can you offset capital gains, but you can deduct up to $3,000 from your ordinary income in any given year. If you still have capital losses and all of your capital gains are offset and $3,000 is deducted from your ordinary income, the rest of your capital losses can be carried over to subsequent years.

The Process

Add up your short-term gains and losses for the tax year and offset the gains with the losses. Do the same with your long-term gains and losses. Finally, compare the short-term gains/losses with long-term gains/losses. For example, if you have a net short-term loss of $6,000 and a net long-term gain of $2,500, you end up with a net loss of $3,500 ($6,000 – $2,500). $3,000 of the net loss can be deducted from ordinary income. The remaining $500 can be carried over to the following year’s income tax report.

Wash-Sale Rule

The wash-sale rule stipulates that a security is disallowed for a loss deduction if a substantially identical security is purchased within 30 days before or after the sale of the security used for the loss deduction. This rule was introduced to prevent the sale of securities just for avoiding taxes.

A substantially identical security is defined as a security from the same company. Purchasing securities in the same sector is not considered substantially identical. For example, buying shares of Best Buy does not prevent you from deducting losses from Circuit City securities. It is not always black and white as to the definition of a substantially identical security. Selling shares of a Vanguard index fund and buying shares of a Fidelity index fund that tracks the same index is a hazy area.

Taking Advantage of Tax Loss Harvesting

Towards the end of the year it’s important to start planning how to minimize your income taxes. Part of the plan has to include analyzing stocks and funds that have the potential to be sold for a loss to offset gains.

If you have securities that are currently valued at a loss, but think they are still good securities to own, you can buy the securities 31 days before or after you sell the securities for a loss. This way you can use the loss to offset gains or ordinary income and still maintain shares for future profit.

Another option when selling securities at losses is to purchase a similar security in the same sector. For example, if you had a securities in the financial sector that were hammered from the sub-prime mortgage mess, you can sell the securities for a loss and purchase other securities in the financial sector. This is appealing a sector suffered significant losses and you think the sector is set to rebound. This strategy allows you to maintain your asset allocation despite selling off losers.


With the stipulation that losses may be carried over to subsequent years, there is almost no reason to not sell losses and take advantage of tax loss harvesting. One reason not to take advantage of this strategy is if you think the exact security you are selling will rebound before you will be able to repurchase. Tax loss harvesting is a significant concept for individuals that do heavy investing in taxable accounts. As soon as I maximize my tax sheltered accounts, I will start investing in taxable accounts and will keep in mind the strategies of tax loss harvesting.

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Maximizing Roth IRA Contributions

September 18, 2008

Once I have completed the down payment on my condo and finished furnishing it, I will direct my savings towards maximizing my roth IRA and a solo 401k. I decided to open a roth IRA instead of a traditional IRA because I wanted to diversify the tax-sheltered retirement accounts. My solo 401k will be funded with pre-tax money, while a roth IRA is funded with post-tax money. Fortunately my AGI is below the contribution limit level for 2008, which is $101,000 so I am eligible to invest $5,000 into my roth IRA. For those of you less fortunate to be making such a large salary, there is a way to invest in a roth IRA for the future.

Contribute to a Roth IRA Even Though You Don’t Qualify

First, you have to open a nondeductible traditional IRA. Everybody qualifies for a nondeductible traditional IRA. In 2010, income limits for converting a traditional IRA into a roth IRA no longer apply. Once the income limits no longer apply you transfer your traditional IRA to a roth IRA. Since you funded your traditional IRA with post-tax money the conversion costs are minimal. The only cost is the taxes on income earned from your investments between now and 2010.

Let’s take this scenario one step further. Most CDs that I have invested in paid out interest monthly. Suppose you invest in a CD that only pays out interest when the CD matures. If the maturation date is after January of 2010 when you convert to a roth IRA, there is no cost associated with converting since there has been no income. Obviously, a CD such as this will provide a lower return as the interest will not be compounding. Before deciding to follow this route, you must investigate how much you save in taxes on the interest versus how much interest you are losing by not compounding.

Maximizing Investments on IRA Contributions

All funds have some sort of annual fee associated with them. At the very least there is an annual expense ratio. When you fund your IRA or 401k, most everybody allows the broker to take the annual fees out of the contribution. When this happens you’re not maximizing your contributions or your deductions. If you send in a separate check that covers your annual fees, the full $5,000 of contributions is invested in your retirement account. In addition, the check you sent for annual fees can be deducted as an investment expense.

If your goal is to maximize your retirement contributions make sure you are truly maximizing your retirement contributions. The tax laws can be confusing, but if understood you can retire much earlier, which is my long-term goal.

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September 17, 2008

I’ve been trying to increase the number of carnivals I participate in to bring more traffic to my sites so maybe I start getting some comments and feedback on my posts. I participated in the Carnival of Personal Finance #170, which was graciously hosted by The Personal Financier. If you were unable to guess, the Personal Financier is a blog about personal finances. Visiting the carnival was my first time checking out this blog and I will most likely be returning. Here are some of my favorite posts from the carnival:

I also participated the Investing Carnival #13 that was hosted by Triaging my way to Financial Success. Here are some of my favorite posts from the carnival:

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Costco American Express Business Card for Cash Back on Gas

September 16, 2008

I recently bought a new LCD TV from Costco. I signed up for a Costco membership to take advantage of the awesome deals on TV’s and for an added warranty. At Costco the price of my TV was $100 cheaper than at Sears. Additionally, Costco tacks on a second year to the warranty and if purchased with an American Express card, a third year is added to the warranty. Since I was signing up for a Costco membership I had to sign up for an American Express credit card. My options for buying at Costco were limited to cash, check or AMEX card. For this reason I decided to open an account for an American Express card.

True Earnings Card from Costco and American Express

The True Earnings card from Costco and American Express provides unlimited cash back for all purchases:

  • 3% for gasoline
  • 3% for restaurants
  • 2% for travel
  • 1% everything else

The True Earnings card also acts as your membership card and it’s always nice to save on wallet space. If you are a Costco member there is no annual fee. The cash back savings accumulate and are issued in the February billing statement. The True Earnings card has an introductory 0% APR for three months on purchases. Balance transfers have an APR of 1.99% for the first 6 months when you transfer a balance during the first 30 days of owning the card.

True Earnings Business Card from Costco and American Express

The True Earnings Business card from Costco and American Express provides the same rewards as the regular True Earnings card, but adds a few more:

  • 5% for gasoline
  • 5 – 10% for select supplies and services
  • 3 – 5% for select travel and entertainment
  • 5 – 25% for select business building tools

A full list of select savings unique to the business card can be found at this link.

My Decisions

Both True Earnings cards are great all around cash back rewards cards. I decided to sign up for the True Earnings Business card to take advantage of the added year of warranty, 3 months of 0% APR and 5% cash back on gasoline. A TV is such a large purchase that it’s nice to get the second and third years tacked on to the warranty. Similarly, with my down payment due on October 3rd and with all of the other purchases that are necessary for my condo, the 0% APR for three months is very nice. Also, I will use this card for all gas and restaurant purchases to maximize my rewards. The only other major purchases that I make with credit cards are groceries, so I will search around and see if I can find a good cash back card for groceries.

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Guide to Frugally Purchasing a TV to Meet Your Needs

September 15, 2008

I recently bought a new big screen LCD TV for my condo. When I was living in my apartment, I was using my roommates’ TV, which was a 42″ Toshiba LCD. For two years I was spoiled with a big screen TV with HD. I thoroughly enjoy watching television. I watch anything sports, especially football. Also, I’m hooked on 24, prison break, heroes, terminator, lost, scrubs and the office. In order to watch all of my stories I decided I had to buy a big screen to replace my roommates’ TV. Below I will explain my search to find as good a deal as possible, while explaining some of the common TV buzz words.

Plasma Versus LCD

Both Plasma and LCD TV’s are flat screens. Plasma TV’s use varied electrical voltages to change the color of plasma gas cells. LCD TV’s use electric charges to vary the color of liquid crystals. Initially, plasma’s produced a superior picture quality, especially in regards to the darkness of the blacks. LCD sets are quickly narrowing the gap in terms of picture quality and blackness levels.

In addition to picture quality, plasmas have a better viewing angles. Also, plasmas have less motion blur during fast motion scenes. LCD’s are narrowing the gap in these areas as well, especially with the new smooth motion technology and ever decreasing refresh rates.

LCD’s tend to have a higher native resolution, which essentially means there are more pixels per area. LCD’s consume less power than a plasma, which is a huge advantage for the frugal minded. The life span of a LCD is most often greater than for a plasma. LCD’s are not usually associated with the burn-in phenomenon, which is the result of a static image left on the screen for too long.

I opted for an LCD TV for power consumption reasons and a higher native resolution.

1080p Versus 720p

1080p was the buzz word for big high definition televisions as recent as last year. 1080p and 720p refer to the screen resolution. A 1080p resolution equates to a 1,920 x 1,080 pixel structure. 720p refers to pretty much every pixel structure below the 1080p, but more specifically it refers to a 1,280 x 720 pixel structure. 1080p televisions are capable of displaying every pixel of HD broadcasts, which is why they were being touted as the latest and greatest. The only problem with 1080p being the latest and greatest is that no HD broadcasts output source material that is 1080p. Even hardcore gamers familiar with the XBOX 360 and PS3 do not experience 1080p outputs. Pretty much the only 1080p output is from Blu-Ray players.

The difference between 1080p and 720p TV’s is hard to notice unless you’re looking at TV screens that are 52″ and larger when viewing non-1080p material. The main benefit of a 1080p TV comes from the ability to sit closer to the TV and still get a high level of sharpness.

As I am a huge movie fan and will be a future owner of a PS3, mostly for it’s Blu-Ray capabilities, I opted for a 1080p television. Also, I wanted a larger screen and wanted to make sure the sharpness is maintained under closer viewing scenarios.

120 Hz

The current buzz word for LCD TV’s is 120 Hz, which refers to the refresh rate. As I mentioned before the early LCD suffered from motion blur during fast-motion content. 120Hz refresh rates are twice as fast as the standard 60 Hz. The main benefit occurs because the 24 frames per second conversion to the TV is an even multiple of 120 and is not an even multiple of 60. This means that each frame is on the screen for the exact same amount of time. Additionally, scrolling text is significantly more crisp.


Anti-judder technology is starting to permeate into the LCD technology. This new technology basically interpolates as to what the intermediate frame would look like if the frame actually existed. It’s almost like averaging the two frames together and guessing at what the middle frame would look like. Most brands have a different catch-phrase for this new technology. Sony calls it Motionflow, Samsung calls it Auto Motion Plus and Vizio calls it Smooth Motion. Most first attempts at this new technology leaves artifacts that are fairly obvious and can ruin the picture. Sometimes the anti-judder looks amazing, and when it doesn’t you can always turn it off.


The top two brands in my opinion are Samsung and Sharp. Sony follows not too far behind. Toshiba, Panasonic, JVC, Pioneer, Vizio, LG and Westinghouse are other common brands. There are even some more obscure brands like Olevia and Sceptre.

Vizio is known as an up and coming brand that first took a foothold in the flat-panel industry by offering budget priced TV’s that provided good bang for your buck. Vizio can not match the quality of a Sharp, Samsung or even a Sony, but the price is significantly less. Most of my information on brand and model quality comes from CNET and AVSforum.

The Winner Is…

I decided to buy one of the new Vizio models, the SV470XVT. It’s a 47″ 1080p 120 Hz LCD TV. Almost every 1080p 120 Hz TV that’s 46″+ will cost you more than $2,000. I paid $1,399 (plus tax), which is an insanely good deal for the most recent LCD technology. Additionally, I bought my TV at costco, which extended the manufacturer’s warranty to 2 years and I paid for it with an AMEX card, which extended the warranty to 3 years.

I highly recommend the Vizio XVT series. I am very happy with the picture quality, bezel design and standard sound. Vizio will be offering wireless 5.1 surround sound speakers, which could make for an awesome A/V setup. The XVT series is Vizio’s first foray into the upper echelon of flat-panel technology, yet they were able to keep the price down. That’s how you frugally purchase a HUGE LCD TV.

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Capital Gains, Losses and 2008 Tax Rates

September 15, 2008

For a couple of reasons I recently started reading up on capital gains taxes. I’m purchasing a condo in the next few weeks with the goal of selling it in a few years and realizing a capital gain. Also, I have a goal of earning a sufficiently high income to fully max out my retirement accounts and still have enough left over to invest in taxable accounts. Investing in taxable accounts requires a thorough knowledge of the effects of capital gains taxes in order to minimize taxes.

Capital Asset

A capital asset is defined as everything you own and use for personal purposes, pleasure or investment. The following are examples of capital assets:

  • stocks and bonds held in a personal account
  • household possessions
  • the real estate you live in
  • your car for pleasure and commuting
  • hobby collections
  • gems and jewelry
  • gold, silver and precious metals

Capital assets are subject to capital gains taxes when sold. For the most part all capital gains are subject to capital gains taxes, but not all capital losses are subject to deductions.

Capital Gain Versus Capital Loss

A capital gain is realized when a capital asset is sold at a price greater than the cost basis. The cost basis is most often, but not always, the original purchase price of the asset. A capital loss is realized when a capital asset is sold at a price less than the cost basis. Some capital assets can not be realized as capital losses for tax purposes, such as a car.

Long Term Versus Short Term Gains and Losses

Long term gains/losses are classified as held for more than a year. Short term gains/losses are classified as held for a year or less. The holding period for an investment is considered to begin on the day after the purchase and ends on the day of the sale. For example, if you purchase a stock on February 20, 2008 you will have to wait until February 21, 2009 to sell if you the gain to be considered long term. February 21, 2008 is considered the first day of the holding period and February 21, 2009 is one year later. It is important to understand the difference between a long term and short term capital gain as they are taxed at different rates.

Short Term Capital Gains Tax Rates

Short term capital gains are taxed at the ordinary income tax rates, which vary depending on income level and filing status. The figure below outlines the short term tax rates for 2008.

Long Term Capital Gains Tax Rates

Long term capital gains are taxed at varying levels according to the short term gains tax rate and the asset class. The figure below outlines the long term tax rates for 2008.

Primary Residence

Primary residences have a special exclusion from capital gains taxes. Individuals can exclude up to $250,000 of capital gains on the sale of a primary residence. Married couples can exclude up to $500,000 of capital gains. The real estate must be used as the primary residence for two of the previous five years. The two years as primary residence don’t have to be sequential or the most recent two years. Unfortunately capital losses on the sale of a principal residence is not deductible.

Capital Losses

Without getting too detailed (I will try to do so in a future post), capital losses may be used to offset capital gains, this practice is commonly referred to as tax loss harvesting. If capital losses exceed capital gains the capital loss may be taken as a deduction with a cap of $3,000. If there is an excess of capital losses by more than $3,000 the losses can be carried over to the next year. Certain capital assets can not be deducted or used to offset capital gains. Real estate and personal property, such as cars can not be realized as capital losses.


A thorough knowledge of capital gains and losses is crucial for investing outside of tax sheltered accounts. Done appropriately capital loss harvesting can have a huge impact on your overall investment return. Additionally, since I am purchasing my condo as an investment property and as my primary residence, I am hoping to take advantage of the exclusion from capital gains after I sell my condo for a huge increase (crossing my fingers). If you are looking for more information on utilizing capital gains/losses to your advantage consider signing up for automatic updates via e-mail or RSS as I will be blogging about tax loss harvesting and cost basis in the near future.

Understanding the Mortgage Amortization Schedule

September 11, 2008

In three weeks I’ll be closing on my condo, which is my first foray into real estate. I’ve been spending a significant amount of my time researching mortgages, interest rates, tax repercussions and pretty much everything that has to do with owning a house. I’ve already written about the basics of a mortgage and the recent trend of interest rates. Most recently I have been reading about the amortization schedule of mortgage payments.

Amortization Schedule

The amortization schedule is the complete schedule of all 360 monthly payments (for a 30 year mortgage) and how much of each payment goes towards principal and how much of each payment goes towards interest. The amortization schedule also shows the remaining principal balance. Understanding how to calculate your amortization schedule is critical as it allows you to really understand how dramatically extra principal payments can decrease the amount of interest paid. In the figure below I’ve laid out my potential amortization schedule with an assumed interest rate of 6%.

To make your own amortization schedule, you have to have your interest rate, monthly payment and the remaining principal value. You take your interest rate and multiply it by the remaining principal value. You take this number and divide it by 12 as you are using a yearly interest rate, the result is the interest portion of the monthly payment. Subtract the interest portion from the total monthly payment to get the principal portion. Subtract the principal portion from the remaining principal value and you begin the process over again until you have no principal remaining.

Initially, the majority of your monthly mortgage payment goes towards interest. In fact, the majority of your payment doesn’t start going towards principal until year 19! The total amount paid in interest and principal after 30 years is $488,303.12. $262,067.12 went towards interest and $226,236.00 went towards principal. If you do not make extra payments towards principal and pay according to the amortization schedule you end up paying 2.16 times the original borrowed value.

Extra Payment Per Year

One plan for making extra principal payments is to make one extra payment equal to the monthly payment at the end of each year. This is roughly the equivalent of making a half-payment every two weeks, or the biweekly method. The following figure shows the amortization schedule if an extra monthly payment is paid towards principal at the end of every year.

As you can see the mortgage is completely paid off after 297, which is just short of 25 years. In year 15 more of the monthly payment goes towards principal than interest. The total amount paid in interest and principal is $401,896.27. $208,213.87 goes towards interest and $226,236.00 goes towards principal. Adding one extra payment per year, which goes entirely towards principal, reduces the total amount paid towards the mortgage by $86,406.85. With these extra payments you end up paying 1.78 times the original borrowed value.

There are numerous services that will try to sell you on the biweekly method, which is a great idea, IF you are not being charged a fee to do so. Jonathan over at My Money Blog recently posted about the do-it-yourself biweekly payment method. In addition to saving money on interest and paying your mortgage off sooner, the biweekly payment method has an added advantage for people who are paid biweekly.

Personal Amortization Schedule Plan

I have not decided how I will try to pay off my mortgage. I am not planning on staying in my condo for much more than five years. I’m assuming I will be thinking about a family and will want to move into a house. As you can see above, I will only have paid off $15,000 of principal, which leaves me with just over $70,000 worth of equity in my condo (between $80,000 and $85,000 if I include the incentives that were deduced from the cost of the condo). I would like to have more equity built up in my condo before I move to make my next mortgage less formidable. For this reason I will try to pay off some more of the principal than just following the amortization schedule. I will determine how much extra I will be paying off once I figure out how I can max out my retirement savings and furnish my condo.

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