When to deduct investment losses...
From a client when sending in info for her 2007 tax returns:
… Also faxing a new item to consider - statement from manager of an LLC I own shares in, in which original investment was $15,000, showing a gradually-declining value of the company to a supposedly-possible low of $0.20 on the dollar. This whole deal is in turmoil with questionable value. Please let me know if some of this decreased-value loss can be deducted on the 2007 return and if some can be carried over or taken in future years...
In regard to the offer to buy out your shares in the LLC, there can be no tax breaks until you actually make the sale. Just the fact that the value of the shares has declined does not justify any kind of loss deduction on your tax return.
This may seem unfair; but it works in both directions. Fluctuations in values of assets do not trigger tax consequences in either direction. Just as the fact that real estate with a very low cost basis may be worth $500,000 right now doesn't trigger a tax on the increased value until you actually sell the property, it is exactly the same thing with decreased values. Since there is always the potential for the value to go back up, you can't claim an actual loss on your tax return until you sell the shares.
This is actually a common issue with many people who evaluate their investment portfolios at year end in the hopes of harvesting some tax losses that can be used to offset other gains they may have. In order to avoid abuses in this area, IRS does have what they call the Wash Sale rule. If the loss stock is repurchased within 30 days of the sale, no deduction is allowed for that loss and it has to actually be added to the cost basis of the replacement shares. I just mention this in case you may be considering selling your shares to lock in the loss and then buying them back. You can do this and claim the loss, as long as you wait more than 30 days to make the repurchase.
I hope this is clear. Let me know if you have any more questions.