3 Tips for Tax Efficiency
Saturday, May 21, 2011 at 5:01PM A more refined version of this is posted here on seekingalpha.com.
Most investors only consider tax strategies at year end and when they do their taxes. While no one wants to spend too much time thinking about Uncle Sam, doing a few things throughout the year can make a huge impact on your after tax returns. Below are a few excerpts and concepts from my "Tax Efficient Investing" paper.
For most investors, absolute portfolio return is the most important factor. This is somewhat unfortunate because there are many other factors to consider such as inflation-adjusted return, risk adjusted return, benchmark performance, and post tax return. This paper will cover some of the basic steps to take to increase your after tax returns.
1. Structure your portfolio for tax efficiency
It is critical to put tax dis-advantaged products such as fixed income, mutual funds (especially if they have turnover issues), and short-term investments into the tax deferred accounts. If there are additional funds to be invested outside of these vehicles, this money should be put into more tax advantageous products such as stocks and exchange traded funds. It can become tricky to balance this with liquidity needs for emergency funds etc. but it can be done.
2. Be cognizant of tax effects
For example, a $10,000 long term stock holding in ABC Co. has a 50% gain and the investor is considering selling this holding for XYZ Co. because he believes XYZ will have higher returns. The question becomes, will the increased returns make up for the fact that the investor will no longer have $10,000 to invest but will instead only have $9,250 after paying the 15% capital gains tax on ABC. The answer lies in the investor’s time horizon as well as any external factors.
3. Harvest taxes
This technique is typically used to offset capital gains an investor has but it can also be used to take full advantage of the $3,000 maximum allowable capital loss deduction. The basic idea is simple; sell the assets in which you have a loss in taxable accounts. All of the losses can be used to offset any gains you have and an additional $3,000 can be deducted from your ordinary income. ...
First of all, you cannot repurchase the asset or a substantially identical asset for at least 31 days from the time you recognize the loss. Secondly, if you only do this at year-end, your portfolio performance will likely suffer. Securities that are down in a given year can come under selling pressure at year-end, which causes performance abnormalities. Therefore, tax harvesting is best done throughout the year.
If you would like a copy of the complete paper or you would like me to contact you, please click here.