Bad investments? Turn them into a tax advantage

Asses your investments for ways to reduce your tax liability

As the end of the year approaches, many advisers recommend investors take a look at their portfolios to assess which assets are performing well and which aren't.

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And if you have a couple of losing investments, you can use them to your advantage by harvesting capital losses.

This strategy involves selling underperforming securities and writing off capital losses against capital gains on other assets to reduce your tax liability.

Long-term capital losses on assets held for more than one year will typically be used to offset long-term capital gains. The same is true for short-term losses and gains.

Extra losses can be used to offset up to $3,000 worth of ordinary income. They can also be carried over into future tax years.

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The strategy can be particularly valuable to offset short-term gains. While long-term gains are taxed at the normal capital gains rate, short-term gains are taxed at ordinary income rates – which, when you add in the net investment income tax of 3.8 percent, can reach as high 40.8 percent for the wealthiest Americans.

However, if you do sell an asset, you cannot repurchase it or something substantially similar within 30 days. This is known as the wash sale rule.

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Glen Smith, managing partner of Glen D. Smith & Associates, told FOX Business there are two ways his office typically uses this strategy for investors.

For example, if a client owns a particular fund, or sector, and it's down for the year – he will sell it and buy a different sector that's poised to do better over the coming months.

Another method involves an investment Smith still likes moving forward, but has underperformed. In this case, Smith said he will buy a new position in the security and then wait more than 30 days to sell the original position. That way he still has a stake in the stock when it regains momentum.

This year, for example, he bought a new stake in Carnival Cruise, which wasn't performing as well as expected, and sold the original position when he could.

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Justin Halverson, a partner and lead adviser at financial planning firm Great Waters Financial, told FOX Business this strategy could be particularly important this year for any non-qualified mutual funds because it is expected to be a big year for mutual fund gain distributions.

Smith noted that during years when the stock market is hot, his firm makes fewer transactions since most positions are making money, and therefore he has less opportunity to harvest losses for clients.

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