Any investment gains that you realize (outside of a tax-deferred retirement plan) are netted against realized losses. Every year, $3,000 in net losses can be deducted against your other income. (The limit is $1,500 for married taxpayers filing separate returns.) Losses that can’t be deducted may be carried forward indefinitely, to offset gains in future years.
Suppose, for example, you add up all your 2001 trades in early December and discover that you have net long-term gains of $7,000 for the year. If you take no further action, you will owe $1,400 on these transactions, at a 20% rate, when you file your tax return the following year.
Instead, you can sell enough losing stocks to realize a $10,000 capital loss. Then you can reinvest the proceeds in a company in the same line of business, choosing one with good prospects for a higher stock price. As a result, your $7,000 net gain has been converted to a $3,000 net capital loss, with no major change to your overall portfolio. Instead of owing $1,400 to the IRS you’ll have a $3,000 deduction, which might save you over $1,000 in taxes.