How to Take Losses While Keeping Your Allocation

Wash Sales

If you have a position in, for example, the Vanguard Index 500 Portfolio, you might think that you can realize a loss in that fund, roll the proceeds into another index fund like the Schwab S&P 500 . Unfortunately, you have maintained the exact same exposure to stocks (index funds have identical investments in Wal-Mart (WMT - commentary - Cramer's Take), General Electric (GE - commentary - Cramer's Take), Johnson & Johnson (JNJ - commentary - Cramer's Take), Microsoft (MSFT - commentary - Cramer's Take), etc.).

The "Wash Sale" rule disallows realizing losses if you roll the proceeds of a sale into a "substantially similar" security within 30 calendar days. You might argue that these funds are run by different fund companies, have different management fees etc., but who really want to have arguments with the IRS? Instead, roll the proceeds of an index fund sale into an actively managed large-cap blend fund like Vanguard Growth and Income.

You might absolutely, positively want to maintain a position in a specific company. You can sell the stock now, and buy it back on the 31st calendar day past the sale. There's a risk that the company will rally substantially over the next month, but it's a risk you'll have to take to capture the loss. You can't use options to lock in the current price because that maintains an open position from the IRS's perspective. For example, you might sell a position in J.P. Morgan (JPM - commentary - Cramer's Take) for $19 a share and buy call options (strike $20, December expiry). Even if you didn't exercise the calls until expiration three months from now, the IRS would disallow your September sale of the stock.

The Bottom Line: No one likes to realize losses, but prudent review of your current situation can retrieve $20-$39 per $100 lost.

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David Edwards is a portfolio manager and president of Heron Capital Management, a New York management firm. At the time of publication, his firm was long General Electric, Wal-Mart, J.P. Morgan, Cisco, and JDS Uniphase, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Edwards appreciates your feedback and invites you to send it to David Edwards.