We are approaching the end of the financial year and it's a good time to start talking about tax loss selling in stocks. Make a calendar note for next year because it's even better to think about it in May than June.
It works like this. Assuming you pay capital gains tax (CGT) – and many of you don't – on June 30 the tax man will effectively freeze your portfolio for that moment in time, add up all the capital gains you've made this year, and all the capital losses, offset the losses against the gains and come after you for CGT on any net profit.
![Capital losses can offset capital gains.](http://web.archive.org./web/20170801033333im_/https://www.fairfaxstatic.com.au/content/dam/images/g/w/p/7/p/8/image.related.articleLeadwide.620x349.gwp7r4.png/1497363383394.jpg)
Don't forget you can minimise (or defer) your capital gains tax liability this year by realising some losses as well as gains before the year end, rather than just holding on. If you have a net capital gain from stocks sold, or any other capital gain, you should now be looking through your collection of current holdings for any stocks with losses attached that you could sell now and in so doing crystallise a loss that can be used to offset any gains made during the year. In so doing, you can minimise your need to pay tax this year. Ultimately it is not about how much tax you pay, that will not change, it is about when you pay it. It is obvious stuff.
But of more interest to investors than the tax situation, and what you may not know, is that this process of tax loss selling impacts on share prices. In particular:
- Stocks that have not performed well over the year, stocks in which a lot of shareholders are holding at a loss coming into the financial year end, tend to get sold down again towards the end of June. Thanks to tax loss selling, bad performers perform badly in June.
- Small illiquid stocks in particular, stocks that have not performed well where again, a lot of shareholders are likely holding at a loss, can get absolutely massacred by tax loss selling in June because the tax-driven selling is forced through when the liquidity is not there. Net result, if you hold an illiquid stock that is running at a loss, take the loss early, because if you wait until the end of June when every other dodo wakes up to it you'll be selling into a last-minute selling frenzy.
- If you do want to take a loss before the end of June, but want to continue holding the stock long term, it is a good idea to take the loss early, now for instance, and not buy it back immediately but wait until the other tax loss sellers destroy it. If all goes well, you can buy it back lower down as the liquidity issue bites the share price closer to the financial year end.
And if you don't have any tax drivers, there is still a "game" you could play here as a trader buying the stocks that get pummelled running into the last week of June. Stocks that are trading favourites always have a lot of stale holders. They are killed in June and often resurrect in July. There may be a trade in there, capitalising on other people's laziness (leaving their tax loss selling to the last moment) and mistakes (buying small illiquid stocks that fell over).
Which stocks do you sell for tax reasons? I could list the worst performers in the last year but it's a bit irrelevant. The stocks that you should target are the stocks in your own portfolio. I don't know what they are, you do, and anyway, you may not have a CGT issue. But if you do, it's pretty clear which stocks you need to focus on – it's the stocks you are holding at a loss. The smaller and more illiquid they are, the earlier you need to sell them and, if you still want to continue to hold the stock long term, the closer to June 30 you buy it back the cheaper you should get it.
And I know a lot of you are in denial about those short-term trades that became long-term "investments", on all those holdings worth $100 that used to be worth $10,000. A common catchcry is that "there's no point selling". But if you have capital gains, there is a point. They, too, have value now.
Marcus Padley is a Director of MTIS Pty Ltd the author of the daily stock market newsletter Marcus Today. For a free trial of the Marcus Today newsletter please go to www.marcustoday.com.au.