Barron’s: Here’s a Strategy for Harvesting Short-Term Stock Losses

The last couple of weeks of the year are when stock investors would be wise to consider strategies for reducing the tax bill that would otherwise be due on any capital gains realized since Jan. 1.
The most obvious is to sell some of your losers, since the resultant losses can be used to offset the gains and reduce or even eliminate the tax otherwise due. But the IRS” so-called “wash sale rule” may be discouraging you from doing so. Fortunately, there are ways of getting around that rule.
First some background: In order to have their maximum tax benefit, losses that you realize should be on stocks you’ve held for less than one year. And, according to the wash sale rule, you must stay out of the stocks you’ve sold for at least 30 days.

That’s the rub: The 30-day period from mid-December to mid-January is often one of the most favorable for beaten-down stocks. Many investors are reluctant to dump their losers right before they may rebound.

The key to getting around the wash sale rule is to find another stock or group of stocks that over the trailing 12 months have been highly correlated with the one you’ve sold. You then can sell your losing stock, invest the proceeds in the substitutes, and then reverse these transactions in a month’s time. The assumption behind this strategy, of course, is that securities that are highly correlated with each other over the trailing 12 months are likely to remain highly correlated for another 30 days.

Even if your substitutes are imperfectly correlated with the stock you have sold, your reduced tax bill will make it more than worth your while to pursue such a strategy. I calculate that the stock you sold will have to do 28% better than your substitutes over the 30-day wash-sale-rule period in order for you to be worse off for harvesting your tax loss.

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