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Many investors look to lock in equity gains as they rebalance their portfolios. These tips can help you limit the tax consequences.
Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
AS YOU REVIEW YOUR PORTFOLIO at year end, and throughout the year, you may consider selling some investments that have increased significantly in value since you bought them. That could be even more true this year. After a bull market that’s lasted nearly a decade, selling high performers can help investors capture long-term gains that might erode if the bull market ends.
You may owe capital gains tax on their increased value, says Joe Curtin, head of Global Portfolio Solutions for the Chief Investment Office of Merrill Lynch and U.S. Trust. At the same time, there may be ways for you and your tax professional to rebalance your investments, keeping them in line with your goals and preferred asset allocation. Remember that capital gains taxes are a result of successful investing, he says. While few people enjoy paying taxes, a capital gains tax of, say, 20% (rates vary depending on your income) “may be a small price to pay for success,” Curtin notes. “You can celebrate keeping the 80%.”
Offsetting gains with losses
Still, there are several strategies you might consider discussing with your tax professional to help reduce what you may owe in capital gains tax, Curtin suggests. “For instance, if a good part of your portfolio is up in value, while a smaller part is down,” he says, “selling some of those ‘down‘ investments at a loss—known as tax-loss harvesting—and claiming the loss on your tax return, could help offset what you owe from your sale of better-performing stocks.” You can generally deduct up to $3,000 (or $1,500 if married and filing separately) of capital losses in excess of capital gains per year from your ordinary income. And if your net capital losses exceed that yearly limit, you can carry over the unused losses to the following year.1
But maybe you want to keep some promising but currently struggling investments in your portfolio. In that case, you could consider selling them, harvest the loss, and then buy them again. Just work with your tax professional so that you’re waiting more than 30 days before repurchasing—if you buy substantially similar investments 30 days before or after the initial sale, you’ll trigger “wash sale” rules and can’t claim the losses on your tax return.
Selling ‘down‘ investments at a loss—known as tax-loss harvesting—and claiming the loss on your tax return, could help offset what you owe from your sale of better-performing stocks.
Taking capital gains in different years
Another option to discuss with your tax professional may be to “spread the sale over multiple tax years—that can help ease the burden,” says Jonathon McLaughlin, investment strategist for U.S. Trust. You might, for example, sell part of an investment that’s performing strongly at the end of 2018, another part during 2019 and the final portion at the beginning of 2020, thereby completing the sale in a little over 12 months while spreading capital gains over three tax years, McLaughlin notes.
But don’t forget that waiting to sell involves risks. The advantages of holding onto those assets, McLaughlin notes, may not outweigh the benefits of selling now and reaping the rewards, even if it comes with a greater tax bill now.
Giving more efficiently
One option you may want to discuss with your tax advisor is to give certain appreciated investments away—either to charity or to your heirs as part of your estate—in order to entirely avoid capital gains taxes. If you regularly give to a specific charity, you might consider giving some appreciated stock instead of cash. You may be able to deduct the fair market value of the appreciated stock if you’ve held the stock for more than one year. The charity may not have to pay capital gains taxes, and you can use the cash you would have donated to purchase new investments. The cost basis, or original price paid (plus or minus certain adjustments for tax purposes), of appreciated investments passed to your heirs through your estate is stepped up to fair market value at death. However, if you give appreciated investments to your heirs during your lifetime, the assets maintain a “carryover basis,” or the same basis you held in the stock.
Any actions you may take should be based on your specific situation and needs rather than your desire to sidestep taxes, Curtin notes. So be sure to speak with you tax specialist and financial advisor before making any decisions.
Read the new Chief Investment Office report "The Capital Gains Dilemma” for a deeper look at strategies to help manage your taxes while pursuing your investment goals. Check out the "2018 Year-End Tax Planning” whitepaper for more insights.
1 Internal Revenue Service, “Capital Gains and Losses — 10 Helpful Facts to Know,” IRS Tax Tip 2017-18, February 22, 2017, https://www.irs.gov/newsroom/capital-gains-and-losses-10-helpful-facts-to-know-0