Tax Tips: How to Make the Most of a Bad Investment

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Bad investmentIt happens to even the best investors: Sometimes, what seems like a smart investment turns out to be a big loser. But even if you suffer a complete loss, you can still salvage something from your experience when you file your tax return.

Whenever you sell an investment that you own, you generate what's called a capital gain or loss. If your investments have done well, then the resulting gain boosts your taxable income, and therefore your tax bill goes up.

But if the investment you sell has lost value, then the resulting capital loss can bring you some tax savings.

Sometimes, though, you'll lose everything on an investment you still own. For instance, when companies declare bankruptcy, their stock often becomes worthless. But if that stock stops trading on the public markets, you may lose the chance to sell your shares to claim your loss.

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Fortunately, the IRS in some circumstances lets you claim a complete loss without actually selling your investment. Known as the worthless stock provisions, the tax law basically allows you to act as though you had sold the shares -- as long as they truly have no value.

To claim losses on worthless stock, you complete your tax forms in much the same way you would a regular capital loss on a stock sale. The sale date is treated as if the loss happened on the last day of the year, and you can put the word "worthless" in the spots for the sale date and sales price columns. But you'll get the same write-off you would from actually selling the shares for nothing -- and you won't have to pay a brokerage commission or other fee to do so.

Obviously, no one wants to suffer a total loss. But if it does happen, you might as well get as much of a tax benefit from it as you can.

For more on smart tax moves:


Motley Fool contributor Dan Caplinger has done fairly well avoiding total losses so far, but he doesn't want to tempt fate. You can follow him on Twitter here.


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The S&P 500's 10 Best-Performing Stocks of 2012 (so far)
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Tax Tips: How to Make the Most of a Bad Investment

10. CA (CA)

Performance: up 26%

Company profile: CA is one of the largest independent providers of IT management software. Revenue from its core mainframe segment represents about 60% of total sales.

Investor takeaway: Shares jumped late in January after the company reported third-quarter earnings rose 32% and announced plans to raise its annual dividend five-fold to $1.

9. Owens-Illinois (OI)

Performance: up 27% (but still down 20% since the end of 2010).

Company profile: Owens-Illinois is the world's largest manufacturer of glass bottles, with operations in 21 countries.

Investor takeaway: For 2011, the company earned $2.37 per share versus $2.60 in 2010. However, it also took a $640 million charge for a variety of reasons in the quarter that resulted in a loss of $4.71 per share on a GAAP accounting basis. It is covered by two analysts, resulting in ratings of one "buy" and one "hold."

8. Freeport-McMoRan Copper & Gold (FCX)

Performance: up 27% (but still down 23% since the end of 2010)

Company profile: Freeport-McMoRan's mines produce more copper and molybdenum than any other company in the world. It also produces gold.

Investor takeaway: Metals mining have historically been highly volatile. Analysts give Freeport-McMoRan eight "buys" and one "hold," according to Morningstar. Two weeks ago, the company reported that fourth-quarter net profit was $640 million, down from $1.5 billion in same period of 2010, but full-year earnings hit a record $4.6 billion.

7. Bank of America (BAC)

Performance:
up 29% (but still down 47% from year-end 2010)

Company profile: Bank of America is one of the largest financial institutions in the world, with lending operations in the consumer, small business, and corporate arenas as well as asset management and investment banking divisions. It just reported net income of $85 million, or 1 cent per share, for 2011, roughly in line with analysts' expectations.

Investor takeaway: The bank faces lots of challenges before it returns to solid fiscal health, but investors apparently think they can be met, given the share-price rise. It was trading at half of book value late last year, so investors may think it hit bottom.

6. Eastman Chemical (EMN)

Performance: up 30%

Company profile: Eastman Chemical is a global producer of chemicals, plastics and fibers, with manufacturing sites in seven countries.

Investor takeaway: During January, the company announced the $4.7 billion acquisition of Solutia (SOA), another chemicals and plastics-making firm, which may have contributed to the price pop. Although it has a diverse international customer base, some of its biggest customers are in the cyclical auto and construction industries. S&P has it rated "buy" and its $60 price target is a 20% premium to the current price.

5. LSI Corp. (LSI)

Performance: up 30%

Company profile: LSI is a maker including of specialized circuits that support applications in enterprise storage and networking.

Investor takeaway: Although it reported a fourth-quarter loss two weeks ago, LSI gave an upbeat outlook for the current quarter, saying it expects revenue in the range of $550 million to $590 million, far ahead of analysts' $511 million, according to data from FactSet Research. S&P's review of analysts' ratings found six "buys," two "buy/holds," five "holds" and one "weak hold."

4. First Solar (FSLR)

Performance: up 31% (but still down 66% from year-end 2010)

Company profile: First Solar manufactures solar modules and turnkey solar systems. It has a competitive advantage due to its technology.

Investor takeaway: The company likely got a boost when, late in January, the MidAmerican Energy unit of Warren Buffett's Berkshire Hathaway (BRK.B) said it has started a new company to oversee a variety of solar, wind and other renewable-energy projects. In December, MidAmerican said it would buy a $2 billion California solar farm from First Solar, lending support to the outlook for the whole industry.

3. Sears Holdings (SHLD)

Performance: up 39% (but still down 40% from year-end 2010)

Company profile: Sears Holdings is the parent to Sears, Sears Canada and Kmart stores and the fourth-largest retailer in the U.S.

Investor takeaway: This troubled stock rose on speculation that its primary shareholder, hedge fund manager Edward Lampert, may seek to take it private. Everything else seems to be going against Sears, including steadily declining earnings, but it does generate significant cash flow, which it has used to buy back shares and pay down debt. But a Morningstar analyst recently wrote that "we don't forecast much growth for Sears, but we do see the potential for a marginal improvement in operating results in 2013-2014 if the appliance market can rebound off current lows."

2. Textron (TXT)

Performance: up 39%

Company profile: Textron's wide-ranging business interests span the aerospace, defense, financial and industrial markets. Its Cessna is the leader in business jets, while its Bell unit is a popular maker of helicopters.

Investor takeaway: Textron is in many cyclical businesses and its defense sector is vulnerable to Congressional budget cutting. For 2012, its management is targeting an 11% improvement in sales, driven by further gains at Cessna and Bell, and $1.80 to $2 per share in earnings, about 35% to 50% higher than 2011's adjusted earnings. Since the end of 2010, its shares are up 8%.

1. Netflix (NFLX)

Performance: up 77% (but it's still down 29% from the end of 2010).

Company profile: Netflix operates a fast-growing DVD rental and video streaming service and its customers are transitioning from DVDs to digital streaming content.

Investor takeaway: Down 60% in 2011 after gaining 219% in 2010, this stock is not for the faint of heart. Recent moves by the management team, specifically trying to raise rates by a huge amount, have added uncertainty to what is already a challenging market for the company as digital service takes over its industry

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