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If you're like most investors, 2001 has been a year you'd just as soon forget. Even before the tragedy in September, the stock market had been slumping - and it's been volatile ever since. As a result, you may be considering selling some stocks at a loss this year to improve your tax situation.

Your investment losses are tax deductible - to a point. You can use your losses to offset any capital gains you may have achieved, plus $3,000 of income. This capability can prove quite useful to you, because even when the markets are down, you can still rack up some capital gains by selling investments that, over time, have increased in value. Capital losses also may offset year-end capital gains distributions you may have received from your mutual funds.

To claim a capital loss, however, you must actually sell the stock - and you might not really want to part with it. You may believe that, despite its current decline, this stock still has good prospects for the future and fits in well with your diversified portfolio. SO, can you sell the stock to establish your tax loss, then buy it back at a lower price?

It's not that simple. In the eyes of the IRS, if you sell a stock and repurchase it - or if you buy a "substantially identical" security - within 30 days, you're making a "wash sale," and you won't be able to deduct any losses resulting from this transaction. And this rule applies to purchases you make within 30 days before or after you sell your stock.

Essentially, you have three strategies for avoiding this wash sale problem. First, you can wait at least 31 days after the sale before repurchasing the stock. Second, you can double your position and then sell your original shares after 31 days. And third, you can sell your shares for a loss and purchase stock of a different company - one that's in the same industry and that has performed similarly to the stock you sold. You can then wait at least 31 days, sell the new stock and repurchase the original stock.

Keep in mind, though, that any purchase you make within the 61-day time frame could violate the wash sale rules. So you'll have to be particularly careful if you've set up a dollar cost averaging plan, under which you buy the same amount of stock shares each month. You'll also have to be alert if you automatically reinvest dividends and capital gains.

Before making a stock trade that could conceivably fall under wash sale rules, consult with your tax adviser. You won't want to make any expensive mistakes. Remember, you have many other options for reducing taxes associated with your investments.

Also, make sure that any moves you make won't upset your long-term investment strategy. It's clearly tempting to try to lock in tax-deductible losses, but it's even more important to maintain a portfolio that's designed to meet your individual needs, goals and tolerance for risk.


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