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Taxes Can Be Good
December 11, 2011
Bradley R. Newman, CFP®

As year end approaches, one of the opportunities for some investment related housekeeping is purging inappropriate holdings from your portfolio. While there are many excuses for not having, and more importantly acting on, a well thought out 'sell discipline', one of the most common relates to the desire of avoiding taxation.

Do you, like many investors, have investment holdings that you've retained to simply avoid paying taxes on the gains? Simply avoiding taxes is not a good reason to hold on to an investment and there are many situations that should cause you to realize your gains, pay the taxes and feel good about that decision; for example, if a holding is no longer appropriate for your situation, a notable change in the underlying fundamentals of the holding, the likelihood of future price movement to be negative, etc.

Tax Tail/Investment Dog
While taxation should always be taken into consideration as investment decisions are made, the reality is that you should make investment decisions based on investment criteria first and tax consequences second.

There are strategies that can be used to offset a tax burden associated with an investment gain, but there isn't much that can be done about losses that often occur when an investment is held too long. If you can't bring yourself to sell the entire position, consider selling a portion of the position by rebalancing the holding down to your original purchase amount.

Capital Gain Taxes Are On Sale
Based on the current tax law, the current Long-Term Capital Gain (LTCG) rate of 15% will likely look like a bargain in 2013 when it is set to rise by one-third to 20%. It is unlikely that we will see a more attractive tax rate on investment gains in the near future.

Taxes On A Payment Plan
While it won't reduce your total amount of taxes due, the end of the calendar year does provide an opportunity to spread the payment of taxes on realized gains over a two year period. If you sell half of a position in late December and then sell the other half in early January, you can split the tax reporting, and payments, over two years to ease your cash-flow. Additionally, if needed, don't overlook the ability to take a distribution from the portfolio to pay the taxes - taxes are simply a cost of managing the portfolio.

100% of Nothing
As noted, tax avoidance is not a sound rationale for portfolio management decisions; over the years, we have regularly encountered situations where the investment loss that was avoided is significantly higher than the taxes were paid. The other common occurrence is seeing situations where tax 'problems' solve themselves as investment gains turn into losses; think of it this way, it's better to get 85% of something vs. 100% of nothing.

We still see new clients coming to us with ubiquitous holdings of the tech era (Cisco, Lucent, Nokia, etc) that were purchased at attractive prices, provided upwards of 300% gains, but are currently held at losses. A common reason for not having sold those positions is 'I didn't want to pay the taxes'.

Sweat The Small Stuff
Beware of some of the pitfalls that could derail your good intentions, such as 'wash-sale' rules or cost basis reporting issues. When in doubt, consult a professional who has the expertise to point out issues that you've not thoroughly considered and to guide you through the process; ideally, hire someone on a fee-only basis in order to avoid the inherent conflict of interest that can arise when transaction based charges skew the recommendations.

Bradley R. Newman, CFP from Roof Advisory Group, Inc., an independent investment management and financial advisory firm based in Harrisburg. The firm is a fee-only Registered Investment Advisor that provides portfolio management and financial planning services for individual and institutional clientele. The firm's email address is invest@roofadvisory.com.

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