Tax Wins From Portfolio Gains

September 8, 2021

Do you have large unrealized capital gains in your after-tax (non-retirement) portfolio? The question of how to strategically plan around large, embedded capital gains has become increasingly popular. The growth of the U.S. and other global economies since The Great Financial Crisis has injected healthy gains into most asset classes in the average investor’s portfolio. Unrealized capital gains represent the price appreciation of an asset that has not yet been sold. Here are a few ideas for tax-efficiently reducing capital gain tax liability in after-tax portfolios. 

Donor Advised Fund

A Donor-Advised Fund (DAF) often makes sense for individuals who itemize on their tax return most, or all, years and who have after-tax portfolios with unrealized capital gains. For example, most people will pull out their checkbook and write a check to a local charitable organization they regularly support. Imagine if this same person contributed a highly appreciated security to their DAF, instead of writing a check. They would receive the applicable tax deduction (for the year of the contribution) to the DAF and would ultimately eliminate their capital gain tax liability in the highly appreciated security that was contributed. The individual could purchase the security that was donated with the cash they would have given directly to the charitable organization. This would increase their cost basis and maintain their position in that same holding. 

Whether contributing a highly appreciated security to a DAF or contributing cash, many contribute to their DAF every other year. This is a common practice because clients do not always have enough deductions to itemize in a single year, therefore, they will make a larger contribution to the DAF in year one to itemize and maximize tax savings. Then, over the first and second year, the individual recommends their DAF to make grants to qualified U.S. public charities of their choice. This allows for a large tax deduction in year one, but also creates a two-year period of steady and predictable charitable giving to the organization.

It’s important to speak with your tax advisor and financial advisor before opening a DAF, as there may be a better strategy for your situation. 

Tax-Loss Harvesting 

The pandemic prompted a market downturn in 2020 and the ensuing volatility has certainly caused some discomfort for many people with substantial financial assets in the market. During these tense moments it may make sense to completing tax-loss harvesting trades. This benefits after-tax portfolios because it may be possible to sell securities at a loss and then then invest the proceeds in other suitable securities to avoid wash sales. After 31 days, you may then the same securities that were sold at a loss to reposition the portfolio in the same holdings and at their target asset allocation. This process locks in realized capital losses that can be used to offset realized capital gains or capital gains distributions in the current year or in a future year. 

If this interests you, be sure to contact a professional investment advisor so they can look for potential opportunities. This is especially helpful if you own appreciated positions that you want to get out of or trim.

Gifting 

Did you know gifting highly appreciated securities rather than cash to relatives can help the donor to avoid capital gains tax on the gifted security? In the right situation, it’s common to gift cash to children or grandchildren. For many, it often makes sense to gift highly appreciated securities rather than gifting cash. This transfers the capital gain tax liability when the security is sold from the donor to the donee. The donee may likely be in a lower marginal tax bracket and, therefore, pay lower capital gains tax rates. Many folks will “gross up” the amount of their gifts to help the donee pay the tax liability. 

It’s important to discuss family gifting strategies with your tax advisor, your financial advisor, and often your estate planning attorney, as there are important tax and estate considerations when developing the right gifting program for your family.

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