Tuesday, March 31, 2009

Tax Tip for Losers

OK. This one just for US Taxpayers (as far as I know).

There is a lot of talk about how the Bush-sanctioned cut in capital gains runs out in 2010 and rates go back up to their pre-2003 levels. Here’s a LINK. And ANOTHER.

However, what NOBODY talks about is that there are a lot of people out there who have tax LOSSES and not gains. Especially after that wonderful market performance of 2008. It’s not like everyone was short.

Capital Losses can be compensated with future capital gains or written off over time, but only at the rate of $3,000 per year. If we all knew how to generate capital gains every year, we’d all be happy and there would be no need for this discussion.

But let’s say you’re sitting on $100,000 of capital losses, because you believed in the stock market or you’re simply a lousy trader. You’ve sworn off stocks. It’s going to take you over thirty years to write off those losses on your 1040.
So you think: I have to generate some capital gains, to compensate this. Easier said than done, since you’ve sworn off the market and now your money is in CDs.

The interest from those CDs is NOT going to compensate your capital losses, since it is taxed as ordinary income.

Here’s where a BOND can help you. Coupon payments from bonds are ordinary income, but if you “sell” them for a profit, it’s a capital gain. Easiest way to get a capital gain from a bond is to buy it at a discount and get 100% at maturity.

So which bonds give you a good chance at that? Junk bonds, of course., but also CONVERTIBLE bonds. Especially if the Convertible feature is no longer worth much, since the strike is far out of the money. These “fallen” convertibles have low coupons and trade at discounts. Not all of them are risky.

Here are few examples of convertibles for LOSERS:

Flextronics 1% 08/01/10 ASK: 92 YTM: 7.4% BB
AMGEN 0.125% 02/10/11 ASK 94,75% YTM 3.1% A+
MEDTRONIC 1.5% 04/15/11 ASK 95.5% YTM 3.8% AA-
AMKOR 2.5% 05/15/11 ASK 82 YTM 12.4% B-
AMD 5,75% 08/15/12 ASK 49.5% YTM 30.9% B-

The coupon part will be taxable as ordinary income, but the capital gain portion (which is the main part in these bonds) will go to compensate your losses. The yields are in line with issuers’ other (non-convertible) bonds.

A broker or planner will normally look at someone in a high tax bracket and send them straight to the muni desk. But if you have losses, here’s a different option.

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