This month: Marcus Padley

As well as offsetting gains, tax-loss selling can provide opportunities to pick up a bargain

Now is a good time to talk about taxloss selling in stocks – something that we really should all think about in May rather than June. But better late than never. It works like this.

Assuming you pay capital gains tax (though many of you don't), on June 30 the tax man will freeze your portfolio, 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.

If your accountant hasn't mentioned it, then this is a reminder that you can minimise ("defer" really) your CGT liability this year by realising some losses as well as gains before the year end, rather than just holding on. Basically, if you have a net capital gain from stocks sold, or any other capital gain, you should now be looking through your 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. 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, it that this process of tax-loss selling impacts share prices. In particular:

• Stocks that have not performed well over the year, stocks that a lot of shareholders are holding at a loss, tend to get sold down towards the end of June. Thanks to tax-loss selling, bad performers perform badly in June. • Small illiquid stocks in particular, where they have not performed well and shareholders are likely sitting on a loss, can get absolutely massacred in June because the 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 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 and not buy it back immediately, but wait until the other taxloss sellers destroy it. If all goes well you can buy it back further down as the liquidity issue bites the share price closer to the financial year end.

• Even if you don't have tax issues, thanks to tax-loss selling trading opportunities can arise, especially in the small, illiquid stocks. Once the tax-loss selling fades away, sold-down stocks can bounce significantly, as small buy orders reboot the prices. So traders should be looking for the lows in small illiquid sell-offs over June, hoping for a rally in July.

But another word to the wise: while you might think you should wait until July and be the first to buy, experience suggests that a lot of the stocks impacted by tax-loss selling tend to bounce a week or so before the year end. So for a trader the game is to identify the stocks getting destroyed and watch for the first rally, rather than July 1, to get stuck in. The rebounds can be just as sharp as the last-minute drops; hesitate and you'll miss it.

Which stocks do you sell for tax reasons? I could list the worst performer in the past 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 and, anyway, you may not have a capital gains tax issue. But if you do, it's pretty clear which stocks you need to focus on – the ones you are holding at a loss. The smaller and more illiquid they are, the earlier you need to sell them. If you 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 catch cry is that "there's no point selling". But if you have capital gains, there is a point. They, too, have value now.

Investors should be aware that the tax office takes a dim view of “wash-sales”. If you do decide to take a loss before June 30 but plan to re-adopt one or more of your dogs in the new financial year, be mindful of the tax office's position on wash-sales. If you repurchase the shares you sold very shortly after at a similar price, the ATO will look at that transaction unfavourably and you may be subject to anti-avoidance rules.