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Playing with the House’s Money – Everyone’s a Winner!

We’re pleased to feature a guest post from Paul Thorstenson, a partner with the Rapid City accounting firm Ketel Thorstenson, LLP

In a Vegas Casino (the House) there is a winner for every loser. Oh yeah, and the House is taking a cut out of the middle of every wager. The more you play the closer your wagers will revert to the “mean” on the big bell curve of gambling and you will certainly lose.

Is Wall Street just another big casino? If you are trading futures or options, it could be described as just that.   Are you really going to be smarter than the experts in the trading pits? Maybe on any given Monday or any given month, but not likely in the long term.

However, buying equities (a/k/a the “stock market”) is different.    Everyone can win!!!   How could that be?  To buy a share of a company, you have to find someone to sell it to you and the brokerage house (middleman) is taking a commission. So what’s different?  The difference with equities is that they tend to go up over time, albeit sometimes the wait is agonizing!!  Good publicly traded companies grow in value for a number of reasons:

  • The economic world around them is expanding,
  • The planet’s population is exploding,
  • Barriers of entry into markets become larger,
  • Companies become more efficient through technology, and most importantly—
  • Companies can raise prices to ward off the silent “cancer” of inflation.

So we can all win, but how can we play with the “House’s” money?  The House I’m talking about is the IRS.  Some stocks in your portfolio will go up and some will go down. When stocks go down, you can sell them and create a tax deductible loss. You can even buy right back into the same or similar security if you “dance around” the wash sale rules (a topic for another time).  The losses can be used to offset gains plus $3,000 per year, and the unused losses carry forward and they only expire when you do.

When stocks go up in value, you only pay the tax when you sell them.  And if you never sell, you will NEVER pay the capital gains tax. The basis starts over or is “stepped up” to FMV at the date of death.  So it is possible to grow your net worth without having to pay any tax on the growth in value, and you may even be able to use $3,000 in losses annually.  Of course, don’t let the “tax tail” wag the dog.  Sell your stocks when it is a good time to sell them. Be aware of the silver lining of deducting your tax losses, and deferring your gains.

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2 Responses to Playing with the House’s Money – Everyone’s a Winner!

  1. Jerry May 5, 2011 at 10:31 am #

    But, Paul. If I wait for the “stepped up” benefit upon death, I lose cause I can’t take it with me 🙂 Jerry

  2. Alan Moore May 5, 2011 at 11:09 am #

    Jerry,

    Your heirs would get a huge benefit since they get a “Step-up” in basis to the current market value. So basically, by tax harvesting, you get a lower basis, you get to offset some of your gains (so less tax) and then your heirs would receive the stocks at your death with a basis equal to market value. In that scenario, tax would never be paid on the gains!