Client Question: Managing Investment Gains

August 18, 2022

Some problems are definitely better than others. A recent client question about possible ways to circumvent a material gain in a taxable account is certainly a nice problem to have – but one that still deserves some discussion.

Investment Taxation Basics

Let’s start with an overview of taxation of investments. If you are buying and selling securities in a taxable account (ie: not a retirement account, such as an IRA, Roth IRA, employer plan, etc)., you are subject to taxation on any activity generated in the account during a given year.

That may include income generated by your securities (ex: interest paid on a bond or dividend paid by an equity holding) – or gains generated by selling securities.

Realized gains are the increase in the price of a security from when you originally purchased it to when you sold it. (And of course, a realized loss is a decline in the price of security from the time you purchased it to when you sold it).

These gains may be generated by your own buying/selling – or they may be distributed by mutual fund holdings (that are required to distribute their capital gains to the individual mutual fund holders)

Give Taxes Their Due

Since net realized gains are taxable (the rate varies, determined by the length of time you have held the security and your other income – as always, consult your tax advisor for details), it is worth giving some consideration the potential tax implications of a trade.

As we always say, taxes are just one part of the equation. You also need to evaluate position concentration, asset allocation, outlook for the security, and many other factors. While taxes shouldn’t be ignored – they also shouldn’t be the sole factor you consider

Ways to Minimize Realized Gains

Here are a few strategies we suggest to clients to minimize/offset realized gains.

  • Recognize losses – This is the most obvious tactic – but one that can be hard to do. Many investors don’t like to feel as though they’ve lost money – and realizing losses can therefore be a tough pill to swallow. However, if you invest for any length of time, it is highly likely that some security at some point in time will be in a loss position. When this occurs, you may consider selling the securities to recognize the loss. Those losses will be netted against your gains. (Note: you don’t need to stay out of the market/in cash if you sell loss positions. You can reinvest the cash in a different security. Please consult the wash sale rules to ensure you don’t negate the losses realized)
  • Carryforward losses – As noted above, there can be benefit in realizing losses. You don’t need to worry about having gains to offset those losses all in one tax year. Current tax legislation allows you to carryforward realized losses indefinitely – and to the extent losses > gains, you can take up to $3,000 per year in losses as an offset to ordinary income as well
  • Donate appreciated stock – This is one of our favorite methods for handling material unrealized gains in positions that clients wish to sell/trim. It essentially keeps the gain from ever being realized, all while generating a charitable deduction! If you have held stock in a taxable account for more than a year, you can donate the stock directly to a charitable organization or a donor advised fund. You will receive a charitable deduction for the fair market value of the stock and will not have to recognize the imbedded capital gain. Win win!

Again, taxes are only one part of the equation when deciding what securities to trim, sell, or hold. However, they are an important piece of the puzzle so be sure to give them their due!

Note: All commentary above is as of the date of this post and is for education and informational purposes only. Windermere and its principals do not intend for this to serve as investment or tax advice and are not responsible for any actions taken based on this article. Consult your financial and tax advisor before taking any actions as it relates to your own investment portfolio

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