Year-End Portfolio Management and Tax Planning

One important benefit of using a portfolio management and investment record keeping system is the ability to utilize and access information for improved year-end decision making, including useful tax planning, monitoring and reporting tools.

This includes lot-by-lot accounting, since in most cases, investment portfolios will consist of multiple assets, acquired at varying times, with different capital gain or loss sale consequences. With the proper investment record keeping and tax planning tools, you can effectively manage your investments to defer taxes, harvest losses, and optimize estate planning.

Deferring Taxes
When selling in taxable accounts, investors must weigh the tax consequences of sales, and the required growth rate of the after-tax investable proceeds to reach goals.

Consider the following example. Investor A sells a stock with an original cost basis of $1,000 for $2,000, 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 now needed for the $1,850 to grow to an expected need of $3,700 over 7 years? 10.4%. In comparison, if this taxable gain is not realized, what growth rate is needed for the original $2,000 to grow $3,700 over 7 years? 9.2%.   This example illustrates that paying the tax any sooner than necessary reduces the amount of principal working for the investor.  By deferring taxable sales as possible, the capital gains tax is deferred, allowing the principal amount to grow.

Harvesting Losses to Reduce Capital Gains
Realized losses on investment transactions are generally deductible, and can be used to offset other realized taxable gains. Additionally, net capital losses of individuals can be used to offset regular income, but is limited to $3,000 per tax year. Any net loss in excess of $3,000 can be carried forward to subsequent years until exhausted. Offsetting capital gains and losses is an effective method that investors should utilize to minimize net capital gains.

One effective method is to sell a security at a loss and then buy another security that is similar to the sold security. Investors need to proceed with some cautions here because the replacement security cannot be “substantially identical” as defined by the I.R.S. see IRS publication 550:

Another method to harvest losses is for the investor to “double-up” on the original security position for 31 days. This method would be appropriate for a position that has performed negatively, yet is still considered a good long-term holding. The investor holds the double-up for 31 days, and then sells the original lot(s) to recognize the loss. If the investor had alternatively sold the security, waited 31 days, and then repurchased, the investor would risk missing any price improvement during that time frame. The harvested loss can be used to offset gains.

Optimize Gift and Estate Planning Strategies
An effective portfolio management and investment record keeping tool will provide essential tools 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, accurate investment record keeping helps investors to identify those purchase lots with the lowest cost basis for gifting. 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, not the cost of the shares gifted. 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 able to defer the gain for a longer time, and the ultimate tax may be less given then longer holding period of the gifted shares.

A portfolio management and investment record keeping system empowers investors with tools for effective tax planning. Investment Account Manager includes many tools that enable investors to identify tax saving maneuvers. If you have any questions, feel free to post your inquiries on our Facebook page.