Tax planning with Investment Account Manager
« on: April 09, 2020, 11:12:25 AM »
One of the many benefits of using Investment Account Manager is its ability to utilize investment record keeping in a manner to be able to access the information to improve decision making. This ability is particularly useful when making tax conscience decisions. An example of this ability can be found in IAM's many useful tax planning and monitoring tools and reports.

A primer:
Investors will find their portfolios consist of many different asset types, purchased over time, and therefore having different capital gain or losses sale consequences. Since capital gains are taxed in non-deferred accounts, albeit at a lower rate, the investor musts weigh the tax consequences of sales. If capital gains can be minimized, by offsetting realized gains with losses, then the capital gains tax is deferred, allowing the principal amount to grow.

Consider the following example. Investor A sells a stock with an original cost basis of $1000 for $2000, realizing a substantial gain. If the investor pays a federal tax rate of 15% on capital gains, the after-tax investable amount is $1,850. What growth rate is needed for the $1850 to grow to $3700 over 7 years? 10.4%. What growth rate is needed for $2000 to grow $3700 over 7 years? 9.2%. The point is that paying the tax any sooner than necessary reduces the amount of principal working for the investor. By smartly using lot-by-lot accounting when selling securities, investors attempt to offset gains and losses thereby deferring the capital gains tax.

Investment Account Manager provides lot assignment when making partial sales either FIFO (First In First Out), Specific ID, Average Cost Method (for mutual funds and Canadian citizens), and Minimum or Maximum Gain.

Lot assignment when making partial sales:
Prior to selling a partial amount of a security, review IAM's Security Basis Report. This report will list, showing in a lot-by-lot view, each purchase you have made in the portfolio. With this information in hand, you can effectively specifically identify which lots to use in a partial sale.

Specific identification allows you to manage the amount of capital gains that will be recognized, thereby managing the capital gains tax that will be due: i.e., if trying to minimize realized gains, then select those lots having the highest cost basis. Note: you must notify the financial institution executing the trade as to which purchase lots to use if you choose the IRS Specific Identification Method.

Now is a good time to consider tax-loss harvesting:
To date, 2020 market performance has been extremely volatile. As such, investors may find opportunities to harvest tax losses.  You may have investments that you are carrying at a paper loss. Now is an appropriate time to review these positions and consider either selling these losers to move into more fundamentally sound securities, and/or to double-up on your positions for 31 days.  After the 31 days, sell the original lots to realize the losses to offset capital gains (IRS rules permit investors to offset gains with losses see IRS publication 551 https://www.irs.gov/publications/p551 )

Examine your asset allocation:
Extreme market volatility will also cause asset allocations to change. For example, is the current allocation in line with your targeted goals for portfolio asset mix (cash v. bonds v. stocks)? Investors should now take the time necessary to review and identify any rebalancing changes necessary to reach long-term goals, while managing the tax consequences of their activity.   
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Taxable vs. tax deferred accounts:
As part of effective portfolio construction taxable vs. tax deferred accounts, decisions are needed to choose which securities belong in which portfolios.  Since IAM provides for multiple portfolio management, it is the ideal tool for segregating your various accounts, while still allowing for the combination of any or all of your portfolios on the various reports. This is particularly useful when managing portfolios and planning to hold investments in the most tax preferred account.

For instance, it may be wise to hold stocks providing qualified dividends in your currently taxable account, while holding stocks that do not provide qualified dividends (i.e. Real Estate Investment Trusts) inside your tax deferred retirement accounts.

Optimize gift and estate planning strategies:
IAM's lot-by-lot cost basis accounting provides an essential element for optimizing gift and estate planning strategies. For instance, after checking with your financial advisor, you may determine that you wish to donate a security(s) to a charity. Since investors often have multiple purchase lots of the same security (IAM summarizes your lot-by-lot accounting on the Security Basis Report), you may find it advantageous to donate those purchases with the lowest cost. Why? When gifting to a qualified charity, the value of the gift is usually based on the market value at the time of the gift, including the unrealized capital gain, and not the cost of the gift. In other words, you will be giving away a larger capital gain that otherwise would have been taxed if you sold the securities and then gifted the proceeds.

Likewise, when gifting to individuals, it may be useful to gift securities with the lowest cost basis, particularly if the recipient is in a lower tax bracket than the donor. The recipient may not only be able to defer the gain for a longer time, ultimate tax will be might also be lower. With lower market prices, gifts might be increased.

« Last Edit: April 09, 2020, 01:10:19 PM by Forum Administrator »