With high incomes and appreciated portfolios, many of our clients around the Bay Area seek relief from paying a large sum to Uncle Sam. Identifying tax minimization opportunities can be difficult as your income and account balances increase; however, there are a few ways you can keep more of what you make. Here are two strategies that we use:
- TAX LOT SELECTION
There are portfolio gains and then there are taxable portfolio gains. When an investor has made multiple purchases of a security, as a result of trades and reinvested dividends, each purchase is a “tax lot.” When the investor sells shares of that security, the tax code allows utilization of one of various tax lot selection methods to determine cost basis and compute taxable gains. The choices include:
- Average Cost
- First-In-First-Out (FIFO)
- Last-In-First-Out (LIFO)
- Highest-In-First-out (HIFO)
- Specific Identification
Each method has pros and cons, and each custodian has its own technological capabilities. How do you know which one is best?
Working through this complex decision is one of the hidden benefits of working with a financial advisor. At The Advisory Group, we use a “tax optimizer” method of tax lot selection to take advantage of the tax treatment of short versus long term gains and losses. When we sell shares of a security with multiple tax lots, we direct the custodian to which tax lots we are selling. Our optimizer method first selects lots with short-term losses, then long-term losses, then long-term gains, and finally short-term gains. This method allows us to minimize our client’s tax liability so they can keep more of their gains net of taxes.
- DONATING APPRECIATED SHARES TO CHARITABLE ORGANIZATIONS
Charitably-minded clients who are also tax sensitive may want to consider donating appreciated securities rather than cash. A donation of appreciated securities results in a double tax benefit to you. Not only do you get the tax deduction for the amount of the donation, but you also avoid all taxes on the appreciation.
If you are interested in making a charitable donation to an organization for 2019, you will need to act quickly. You will want to contact your advisor by mid-November to arrange for the donation to be made in-kind. At The Advisory Group, we execute this strategy as follows:
- Identify the shares in our client’s account with the lowest cost and greatest unrealized appreciation,
- Prepare the paperwork to initiate the in-kind donation,
- Work with the custodian to make the asset transfer, and
- Re-purchase that security when our client restores funds into the account.
It’s a win for the charitable organization and a double win for you!