Capital Gains Strategies
From the Orange Couch

Robin:
Hi, this is Robin Tull. I am coming to you from the infamous Orange Couch, where today I have Drew Overton, our Director of Tax and Financial Planning. Drew, you’re also finishing up your Master of Accounting.

Drew:
That’s right, at ODU.

Robin:
Today, we want to talk about some practical steps our clients are asking us about taxation. The purpose of the Orange Couch is to answer questions from you or questions we are getting in our meetings, and one of them is about tax planning as it relates to investments. We’re really just talking about taxable accounts today, and we want to give you some practical steps.

Robin:
What we’re seeing is if you had a portfolio that was invested in 2000 and you set it up in an allocation of 60% stocks and 40% bonds, if you look at it today and haven’t rebalanced, there’s a good chance it’s closer to 80% stocks and 20% bonds. Why people let that happen is because they’re concerned about the tax liability if they sold that stock. What we want to do today is to give you some practical steps because it’s important to stay close to your investment policy. What are some things that you’re seeing?

Drew:
At Tull Financial Group, we rebalance accounts every February. While there’s no tax bill in placing trades in IRAs, for taxable accounts, it can be painful to pay that tax bill and try to reset the allocation. Investment policy statements are on file for everyone — whether it be a 60/40 or a 75% stocks / 25% bonds — we want to make sure we are respecting that and keeping that in check. We’ve had a strong run up these past three years, and that has gotten some accounts out of whack. What we need to do is trim the gains and pay the tax bill. Today, we are answering the question on how best to do it.

Robin:
One of the things we try to set up with clients is a capital gains budget. Do you want to explain what that means?

Drew:
Before you come to the table to rebalance, you want a predetermined capital gain amount that you’re okay with — $10,000, $20,000, whatever that amount is. We try to do that with every account, every client. What’s even better is to have a tax return in order to make a personalized budget. We had a client that came in yesterday; $50,000 was the number. We could realize that amount and it wouldn’t impact anything else. For them, you could tax it at a 0% rate instead of the more common 15% federal rate.

Don’t let the tax determine your decision on your investment allocation. We want to pay that bill. We also want to look at how that relates to your tax return and whether it may impact anything else.

Robin:
People are concerned about the return on that money, but if you have $100,000 and a $6,000 liability to the IRS, your account is really only worth $94,000. You’re going to have the tax no matter when you sell it. Can you explain what the benefit might be?

Drew:
We take a holistic approach. If you were to take that $6,000 in that example and pay the tax to the federal government, instead of $100,000, now you have $94,000. If you were to keep that  $6,000 in the account and let it grow and not reallocate your portfolio, that $6,000, assuming an 8% rate of return, is only going to generate about $480 for the year. Mathematically, that’s only about a half-percent of return you’re giving up.

Robin:
A few years ago, we acquired several accounts that held large positions in gold that had grown significantly. Many of the clients did not want to sell because of the tax. Down the road, they did not have the tax liability and much of that growth had disappeared when gold pulled back. It’s so important to trim and take some of the gains early on and go ahead and pay the tax. What’s another practical step we can do today?

Drew:
The capital gains budget is crucial. If a client is charitably inclined, there is a way you can donate stock instead of donating cash, where you get the itemized deduction for the charitable contribution. You not only get that value of the charitable deduction, but you also get the capital gains forgiven.

Drew:
We have a client who loves Tesla and has held the stock forever. Selling it would have created a hefty tax bill. He also happens to be charitably inclined, so he donated the stock, received the charitable deduction and eliminated the capital gain. The cash he would have used to donate to charity, he just bought Tesla right back.

Robin:
You can buy that stock right back and then start over at a higher basis.We encourage donor-advised funds, which is such a nice tool. Vanguard, Fidelity and Schwab offer them. It’s like having your own foundation as you can name it. The idea is you can put the highly appreciated stock in the donor-advised fund to get an immediate tax deduction and the capital gains are forgiven. You can also transfer it to a charity whenever you want. We see a lot of people do that at year-end when they want to get a tax deduction. Then they give to charity later on. Donate and also buy back are great strategies.

Drew:
The donate and replace strategy, the capital gains budget — getting away from letting the tax tail wag the dog. Don’t let that make your investment decisions. Those are two practical ways we help our clients every day and a big reason we ask for tax returns.

Robin:
Good advice. If you have questions or concerns, please give us a call. If you want to talk about your portfolio and how to reduce your tax bite, Drew will be glad to talk with you. Thank you for joining us today and have a great day.