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If I have long-term capital gains and short-term losses, I know I can offset the long-term gain with a short-term loss. But I've read that is not what you should do. Why? If I reduce my taxes from the gains, why does it matter if I use short-term losses? Would it be best to take short-term gains just to use the short-term losses? If so, please explain. -- Ron Dunn


When deciding what shares to sell, please base your decision on sound investment logic. Don't get caught up in the tax minutiae. Just sell what you want to sell.

Granted, in a perfect world, if you have a short-term gain, you'd want to sell something that would generate a short-term loss. But you shouldn't make a sell decision based only on taxes. That trade must make perfect investment sense. We'll walk through the details of this Utopian world now, but know that in the end, your gains and losses are netted against each other and it doesn't make a big difference whether some are short term and some are long term.

Your gains and losses are netted in a distinct

pecking order. First, short-term gains are netted against short-term losses and long-term gains are netted against long-term losses. Then the net long-term gain or loss is combined with the net short-term gain or loss to create your final capital gain/loss number.

So if you have a net long-term gain of $10,000 and a net short-term loss of $5,000, you end up with an overall $5,000 long-term gain.

But what if all you had was one long-term gain of $10,000 and one short-term loss of $5,000. The end result would be the same. You'd still have a total long-term gain of $5,000. In this instance, though, using that short-term loss against your long-term gain is not the most efficient use of your short-term loss, says Rande Spiegelman, a senior manager with


investment advisory services group in San Francisco.

Why? Because you owe ordinary income tax on your short-term gains, which could be as high as 39.6%. If you have a long-term gain, you'll owe capital gains tax at 20% (10% if you're in the 15% ordinary income tax bracket). And for folks in the higher tax brackets, that's a good rate to hold onto.

So ideally you'd like to wipe out those short-term gains first. In a perfect world, if you have the option to choose between a short-term loss and a long-term loss, assuming it makes good investment sense to sell either, you'd want to sell the short-term shares.

"But this is a very rare circumstance so don't get too hung up on it," says Spiegelman.

Hedging in an IRA?

I have an IRA so I am limited as to the different ways I can hedge. What would you recommend is the best way to offset a down market in an IRA? -- Candace Orleans


I'm not sure why you want to hedge your IRA. A good time to create a hedge position is when you have a position with large gains and you're afraid the market is going to fall but you don't want to sell everything and pay capital gains tax, says Spiegelman. Instead, you buy a little insurance premium that -- let's hope -- costs less than the tax hit you'd incur if you dumped everything.

But you don't owe capital gains tax on any sales in an IRA. So if you're afraid that the market is going to keep sinking, just sell your precarious holdings and put your money in more comfortable positions.

If you really can't sleep at night because your retirement money is slipping away, then consider reallocating your portfolio into more conservative holdings. And depending on your IRA custodian's investment policies, you may be able to purchase put options to protect big gains in your long positions. A put option is the right, but not the obligation, to sell a specific amount of a given stock at a specified price by a certain date. In periods of turmoil, put options can help you sleep at night without to having dump shares into the falling market.

Note that you can't sell short or use margin in your IRA, says Spiegelman.

As always, your best line of defense against a perilous market is a solid asset allocation -- especially in your retirement account.

George W.'s Tax Plan

I don't want you to think I'm being remiss and ignoring our president-elect's tax policies. But this is a quick note to let you know that I'm not going to opine on whether or not Dubya will get his tax policy through Congress. But I will say that since House Speaker Dennis Hastert came out and said he wasn't enamored of Bush's $1.3 trillion tax-cut proposal, this doesn't make passage a given thing. (For more details on his policy,

check out this story.)

But I have a better shot of predicting who's going to be in the next

Super Bowl

(ask me the last time I watched a football game) than I do of trying to predict what our 43rd president is going to accomplish during his tenure.

Nor am I going to waste your time with a bunch of pundits' arbitrary guesses. No one knows and anyone who tries to tell you he does is lying.

Have a great weekend.

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TSC Investor Forum aims to provide general investment information. It cannot and does not attempt to provide individual advice. All readers are urged to consult with a professional as needed about their individual circumstances.