The Silver Lining in Your Bad Stock Picks / You Can Use the Losers to Offset Taxes on the Winners

Tom Herman for the Wall St Journal writes: Many investors, basking in the glow of the stock market's strong performance this year, may benefit from a technique known as tax-loss harvesting.

This tax-smart maneuver has existed for ages. But it is especially timely now because of higher tax rates that took effect at the beginning of the year.

While stock-market winners may feel great, this is a good time to see if you have any losers. If you were thinking of dumping the losers for investment reasons, consider selling—or, as tax geeks say, "harvesting your losses"—before year's end. Nailing down those losses can cut your tax bill for this year.

The basic rules are simple: You can use capital losses to soak up capital gains on a dollar-for-dollar basis. (Paper losses don't count.) Suppose you made a $25,000 profit this year selling a stock you bought years ago. Now you sell another investment that you've owned for years, and you incur a $25,000 loss. That loss offsets your entire gain.

If your losses are bigger than your gains, you can typically deduct as much as $3,000 a year of that net loss ($1,500 if you're married and filing separately) from your other income. This is an especially valuable technique for investors in the upper tax brackets. Additional losses get carried over into future years.

Make sure you don't get soaked by the "wash-sale" rules. The IRS says a wash sale typically occurs when you sell securities at a loss and, within 30 days before or after the sale, you buy substantially identical securities. If you violate the rules, you can't deduct your loss this year.

If your loss isn't allowed because of the wash-sale rules, the IRS says, you can typically "add the disallowed loss to the cost" of the new securities. The sum is your basis in the new securities. The adjustment postpones the loss deduction until the sale of the new securities.

For more, see IRS Publication 550.