Providing insight from more than 32 years of financial industry experience helping you to make better financial planning and family planning decisions.
One of my favorite holidays is the 4th of July, especially when it comes on a Thursday to create a 4-day weekend. I love the summer and July 4th means that summer is in full-swing. I also dislike when it quickly goes by because before you know it we are into mid-September and we just blew through Labor Day weekend. Thanksgiving Day is almost upon us and Christmas is not far away. This means that the end of the year will come very soon. I’m sure you are thinking about presents right now but you should be thinking about taxes!
Most people only think about taxes when it is absolutely necessary like on April 15th, completing paperwork for a new employer or choosing options for a 401-K plan. You should be thinking about taxes at some point every year as a way to plan to pay the least possible amount going forward. One of the easiest forms of tax planning is tax-loss harvesting. Tax-loss harvesting involves selling your losers before the end of the year to book a capital tax-loss. Some advisors recommend that you sell the security in which you have an unrealized capital loss and buy a similar security or wait 30 days and buy back the same security. I manage my client’s portfolios with taxes in mind all year round, not just at the end of the year.
If you haven't had a discussion about tax planning for this year with your investment adviser by now it can only mean two things. Your adviser is an RIA (Registered Investment Adviser), has discretionary trading authority and has done planning for you and your family in a comprehensive way. This would mean the adviser knows what needs to be done to minimize taxes based on your planning sessions. This is a good thing. Your adviser is not a RIA and/or a CFP (Certified Financial Planner), your adviser does not have discretionary authority and you have not had any comprehensive planning done. This is a bad thing. It means you probably aren't going to be taking advantage of tax losses which might be in your portfolio. Not every investment goes up all the time. There are winners and losers.
I might sell a security in March if I believe it is the right thing to do at that time, regardless of the tax consequences. First and foremost you own any investment because you believe it is a good investment to hold at that time. Buying and selling any investment or asset strictly based on tax considerations is not very sound investment strategy. When you do sell any security that you've held for more than one-year you'll have a long-term capital gain or loss. When you sell any security that you've held for less than one-year you'll have a short-term capital gain or loss.
The key is to effectively offset losses against gains whenever possible: long-term losses against long-term gains and short-term losses against short-term gains. Short-term gains are taxed are your regular income tax rate while long-term gains are taxed at the capital gains tax rate. We're used to the long-term capital gains rate being lower than your regular income tax rate but this is not necessarily true by definition. Congress has the ability to change both rates every year.
Take a look at your unrealized capital losses and gains in your portfolio. Unless you have a specific estate planning function in mind, it’s usually better to spread out your gains over time while maximizing any potential tax-loss harvesting. If you have a specific holding that represents a good percentage of your overall portfolio and it has substantial embedded capital gains, your tax liability will only continue to grow. At some point (unless you die and use the step-up in basis rule) you may need the money or want to reallocate your portfolio and you'll find yourself with a huge tax bill all at once. With proper planning and using the right adviser you’ll find that you don’t need to worry about taxes come the end of the year. Your tax planning should be an on-going process just like the buying and selling of your securities.