Maximizing Returns: Investing with Taxes in Mind

By Michael S. Brown on June 21, 2014
Previously published on June 16, 2014 in the San Diego Business Journal.

“The hardest thing in the world to understand is the income tax.” — Albert Einstein

Many investors and high earners are still stinging from the impacts of new federal tax rules that went into effect in 2013, which included:

  • Increased tax rates on long-term capital gains and qualified dividends for those in the highest tax brackets
  • New Medicare taxes on net investment income and wages
  • A new top marginal federal income tax bracket of 39.6% (applicable to earned income, interest, nonqualified dividends, and other income)
  • Phasing out of personal exemptions and itemized deductions for high earners

Fortunately, several basic strategies are available to investors to reduce taxes.  While Dowling & Yahnke has employed these strategies for more than two decades, they are more relevant than ever given the new tax rules.  We coordinate closely with our clients’ tax advisors to execute the tax-saving strategies described below, along with other more complex strategies, to optimize after-tax investment returns for each client.

Asset Location

Asset location refers to the thoughtful distribution of investments among accounts with different tax attributes, such as taxable accounts, tax-deferred accounts (IRA, 401(k), and other retirement accounts), and tax-exempt accounts (Roth accounts).  Taxable bonds and real estate securities, which generate ordinary income taxed at higher rates, should be held in tax-deferred accounts.  Assets that generate capital gains and qualified dividends, which are taxed at lower rates, should be held in taxable accounts.  Depending on the situation, municipal bonds (which can be tax-exempt) may be used to meet fixed income needs in taxable accounts.  Asset location strategies will cause accounts with different tax attributes to have varying performance, so it is important to focus on the performance of the overall portfolio rather than individual account performance.

Tax Loss Harvesting

Inevitable declines in the values of individual holdings in taxable accounts may be used to reduce current or future taxes.  Even in a year like 2013 in which a diversified portfolio of stocks and bonds increased significantly in value, opportunities to sell individual positions for tax losses occurred.  For example, a stock purchased for $10,000 that declined in value to $8,000 could be sold to book a $2,000 loss for tax purposes.  The stock may be repurchased after 31 days under the IRS wash sale rules (or other strategies may be employed) if the investor desires to own the stock for the long-term.

Managing Capital Gains

Long-term capital gains, which apply to assets held for more than a year, are taxed at lower rates than short-term capital gains.  While taxes should not drive investment decisions, the timing of gain recognition and holding periods of assets should be strongly considered when selling since the difference between long-term versus short-term capital gains tax rates can be significant.  Also, investors should consider rebalancing their portfolios using tax-advantaged accounts when possible to minimize current taxes.

Gifting Appreciated Securities

Investors making gifts to charitable organizations can save significant taxes by donating appreciated securities in lieu of cash.  Subject to limitations, if a security held for more than one year and one day is donated to a public charity, the amount that can be claimed as a deduction is the fair market value of the security on the date of the gift.  The donor benefits greatly, since a tax deduction is received for the fair market value of the asset on the date of the gift with no capital gains tax paid on the appreciation of the gifted security. Dowling & Yahnke helps high-net-worth clients achieve their financial goals by building customized, risk appropriate, low-cost, tax-efficient investment portfolios.


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