Baby boomers are living longer, but perhaps facing more challenges than ever. Healthcare costs, layoffs and lack of pensions greatly affect financial planning. We must budget our lifestyles to meet rising costs and uncertainty. In certain cases, this may include taking investment profits.
Investors of all ages may sell investments for various reasons. These include:
- Meet other tax liabilities: Proceeds to deal with outstanding taxes.
- Portfolio Rebalancing: Bring your asset allocation back in check with time horizon and risk tolerance.
- Cash to meet living expenses: Longer life expectancies and increasing costs may cause cash flow issues. Insurance may not cover certain medical procedures or costs.
- Cover leisure costs: Take a dream vacation or other fun activities.
Whatever the reasons for selling, you have options to minimize capital gains when taking profits.
Two options include:
- Specific Identification Method
- Tax Loss Harvesting
Let’s take a look at how each of these methods trims your tax bill:
Specific Identification Method:
When you sell investments, the IRS assumes shares that were bought first are being sold. This is otherwise known as FIFO. (First In First Out). If older shares were purchased at lower prices (low cost basis), you will realize a larger taxable gain when selling.
Specific Identification allows you to specify which shares are being sold to reduce this tax liability. Higher cost basis shares will have less profit, which cuts capital gains. Money Manager Elliott Broidy is an investor known to consider tax efficiency when making portfolio decisions. However, specific identification is readily available to individual investors, as well.
Best Practice: Specific Identification is more effective with organization and planning.
- Calculate needed funds: Specific identification works well with predetermined sums. Example: You need $5300 to pay federal taxes. Start with high cost basis shares and work backwards until the amount is reached.
- Online Account Management: Your online brokerage or mutual fund accounts should sort by purchase price, share quantity and date.
- Execution of Sale Orders: Be specific and confirm when selling shares over the phone.
- Online Trade Execution: Look for a ‘Special Instructions’ tab on your sell order screen. Please call the help desk for questions.
Tax Loss Selling/ Harvesting:
Most of us have made portfolio choices that do not pan out. Pride often makes it difficult to sell these flops. Harvesting capital losses is financial incentive to part with losing investments.
Overview: You can apply up to $3,000 in losses against ordinary income for the tax year. Any balance is carried forward and available for future years. (In $3,000 increments)
Items to consider:
- Wash Sale Rule: The wash sale rule is a caveat to harvesting losses. What does it mean? You cannot buy the same security 30 days prior or after sale to claim a deduction. However, investors may buy a similar security. So, you can buy another semiconductor stock to meet asset allocation needs, etc.
- Tax loss sales and taking profits often have similar motives. For instance, you may sell a stock for changing fundamentals. The security may have a gain or loss at the time. Your options with a gain or loss are where the difference lies.
One Aspect of Tax Planning:
You can make more informed decisions by knowing the tax strategies available for your situation. A tax professional should be consulted for assistance, as needed.