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Lindley Estes is a business writer for The Free Lance-Star and This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.

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Last call to reduce your capital-gains tax exposure

IF YOU’VE MADE some bad investments this year, tomorrow is your last chance to use these errors to reduce capital-gains tax exposure.

Tomorrow is both the last day of 2007 and the final time the stock market will be open this year.

Investors holding stocks that have dropped below their purchase prices can sell the holdings to offset realized capital gains. If the losses exceed the gains, they can offset up to $3,000 in ordinary income. Losses of more than $3,000 can be carried over to next year.

James Stewart wrote an excellent column in the Dec. 19 edition of The Wall Street Journal about this strategy. The column was titled “Tip for a Down Market: Make the Most of Losses.”

As Stewart points out, due to recent fluctuations in the U.S. and global stock markets, many investors are likely sitting on unrealized losses in their portfolios.

Stewart’s advice? Ruthlessly go through your portfolio and sell holdings with losses. You can always buy them back after 30 days have passed under the IRS’ “wash sale” rules.

“Why pay even reduced capital-gains taxes if you can offset the gains?” Stewart asks readers.

Of course tax implications aren’t the only factor to consider when deciding whether to hold or sell an underperforming stock. If you believe the stock is wildly undervalued, it might not make sense to sell just to save a little money on taxes.

But many people refuse to sell losing investments because it is admitting a mistake, writes Jason Zweig in his book about the emotions of investing titled “Your Money and Your Brain.”

Rather, Zweig writes, many investors will stubbornly cling to their losers, waiting in vain for them to return to the break-even mark. If a mistake was clearly made, why not just sell, enjoy the tax benefits and put your money in more-promising investments?

Stewart also addresses the other side of the issue–what to do with stocks that have soared above their fair values? Stewart says it’s folly to hold overvalued investments just to avoid paying the tax man. That’s especially true with the long-term capital gains rate at a historically low 15 percent for most investors–a rate that could rise in coming years.

“There are far worse things than paying taxes,” Stewart points out. “You have to pay only if you make money, which isn’t such a bad problem to have.”

The moral of the story? Taxes are just one factor in making your investment decisions. But if there is good reason to adjust your portfolio for tax purposes this year, be sure to do it tomorrow.