Recouping losses
One of the best ways to help investors through the tax code is being ignored in the debate over the Bush economic plan. The idea of raising the cap on deductions for investment losses deserves more attention.
By Larry Dignan
March 25, 2003
|
So the president wants to cut taxes on your investment gains. But what about easing the pain of your losses?
The Bush administration's proposed budget aims to revamp the tax code, largely through the widely-discussed elimination of taxes on dividend payments. But many observers hoping for tax relief on the other end were disappointed: the president's proposal wouldn't increase the amount of investment losses that can be deducted from income -- an issue that most investors can sympathize with, given the bear market of the last three years.
The investment loss deduction for most people is capped at $3,000 -- a limit that hasn't been raised since 1978. The House Ways and Means Committee at one time proposed raising the cap to $8,250 and indexing it to inflation, but the effort stalled. Analysts had expected Bush to propose raising the limits, especially when you consider the budget already includes harder tasks such as eliminating the double-taxation of dividends and revamping savings plans.
"It's mindblowing," said Gary Schatsky, president of ObjectiveAdvice.com. "This is the one thing that would have had the broadest appeal. Maybe the White House viewed it as a potential straw that would break the camel's back."
But that straw has a lot of support. After all, plenty of investors have lost more than $3,000 in a year after the stock market bubbled burst. Academics argue that the current limit may affect investor psychology, making it easier to hang onto losers. For example, if you lost $24,000 on a stock, the most you could write off is $3,000 each year until you reached the total; that's eight years to write off a loss. If the limit were raised, investors may dump losers quicker and reinvest capital more efficiently. "A lot of modest income folks have lost more than $3,000," Schatsky said.
Realizing politics play a big part in tax debates, financial advisers note that raising the investment loss limits would be an easier sell than ending dividend taxes -- even though both could be panned as handouts to the wealthy. Traders, who count on investment income as ordinary income, can write off larger losses.
Meanwhile, many observers have problems with a $3,000 investment loss cap. The rule is inherently unfair, said Jim Greenleaf, a finance professor at Lehigh University. "If you win in the stock market, the government wants to reach in your pocket," Greenleaf said. "If you lose, the government defers your ability to write off losses."
The Lehigh professor also argues that the $3,000 investment loss limit doesn't exist for other asset classes -- notably real estate where you can take a $10,000 loss from ordinary income. Greenleaf's solution: invest in qualified plans or tilt toward other investments. "It's not a level playing field," he said.
Although it's easy to get people to agree that the $3,000 loss limit has problems, things get sticky when solutions are pondered. Some finance experts are calling for a much higher cap, although many analysts noted that if you go too high -- $20,000 perhaps -- it wouldn't be politically feasible. Other observers propose adjusting the current cap for inflation, which would put it in the $8,000 range. And some analysts want to do away with the cap altogether and let investors write off all their losses.
Why the wide range of opinion? Because for all the speculation, no one really knows how a change in the deduction would affect investor behavior. There could be unintended consequences, such as increased market volatility.
"In fairness, you have to raise it, but you have to be careful about what the limit will be," said Bruce Primeau, director of wealth management services at Wade Financial Group. "If it's raised it should be done slowly over time."
If the rate were raised too high, investors would be rewarded for taking big risks largely because their losses can be written off. "If you could write off $50,000 you'd take all your losses before year end and it could add to volatility," Primeau said. "A lot of big names would be driven down even more."
Schatsky disagrees, arguing that a raised limit would encourage more investors to reposition their portfolios. "You would see more movement, but it would reduce the sting for people," said Schatsky. "People may view equities as more appealing."
Diane Pearson, a financial advisor with Legend Financial Advisors, said investors should be "harvesting" losses even with the $3,000 limit. "If people bank their losses, it'll pay off when they rebalance portfolios and take gains," said Pearson.
It's not entirely clear how many investors hang on to losers because they can't write off more than $3,000 in losses, but financial planners believe there are many people who fall into that category.
"People find it very difficult to sell things when they are in a loss position," said Tom Davison, a financial planner with Summit Financial Strategies. "Cold hard logic says 'Where is my capital today, and where is the best place
to put it?' Emotion says 'I own this turkey, but maybe it will turn back into the eagle, or at least a songbird, and I'll come out even. I'll wait until then and sell.'"
According to Davison, the raising the investment loss limit would help "emotionally handicapped" investors dump stocks. Under current rules, investors only sell enough to get the tax loss, keeping bad investments.
"There is a tendency to hold losers and hope they come back," said Richard Krentz, principal of RDK Financial Group. "The question should be 'I bought Cisco at $85 and now it's $14, would I still buy it?' In many cases the answer is 'No.' (But) if the limit was raised, maybe they'd be forced to take the losses."
|
