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The goal of any investor should be to buy assets that appreciate in value over time. Thus, the old investing adage: Buy low, sell high.
Sometimes, however, investors get attached to appreciated assets and don’t want to sell them. This is usually because they don’t want to pay taxes on the increase in the asset’s value. If the asset has been held for at least one year, the appreciation is subject to capital gains tax that’s currently as high as 20%.
But if the asset is never sold, the gain will never be realized — it will always be a “paper gain.” So, it’s important to know when the right time is to sell appreciated assets, realize the gains and pay Uncle Sam what you owe.
There are reasons other than taxes for hesitating to sell appreciated assets. For example, sometimes investors can get emotionally attached to securities. This is especially true if it’s the stock of a company you work for (or used to work for), the stock was inherited or if the stock was gifted to you by a loved one.
In addition, some investors won’t sell appreciated assets due to simple inertia. It’s often easier to just leave things as they are, especially if they’re working out well. In other words, “if it ain’t broke, don’t fix it.” And, yet another reason for not selling may be the belief that an asset will appreciate even more in the future. This is sometimes referred to as FOMO — or Fear of Missing Out on even more gains.
There are dangers to holding onto appreciated assets too long that go beyond never realizing your gains. For example, over time an appreciated stock can end up becoming a concentrated position, knocking a portfolio’s asset allocation out of whack.
When this happens, it may be time to sell the stock and use the proceeds to buy other assets, perhaps in another asset class (e.g., fixed income or cash), in order to diversify the portfolio and bring things back into the proper balance. This is referred to as portfolio rebalancing.
Here are a few strategies to consider if you own highly appreciated assets:
For example, suppose you bought a stock position 10 years ago for $50,000 and it’s now worth $100,000. The taxable capital gain would $50,000, resulting in a tax bill of $10,000 at the 20% capital gains tax rate. You could sell off the position over four years and spread out the $2,500 in capital gains tax over this time.
In addition to spreading out your tax bill on appreciated assets, there is another approach that may allow you to offset the gains on an asset by utilizing a strategy called “tax harvesting.” With this, you can sell shares of a different portfolio asset in which you have a tax loss, therefore lowering your potential tax bill. Your financial advisor can assist you further in using this approach within your portfolio.
• Donate the assets to charity. Not only will this save capital gains taxes, but you may also receive a tax deduction if you make the donation to a qualified Section 501(c)(3) organization. The charity will receive the full current value of the asset and you’ll be able to donate (and deduct) more than your cost basis (or what you originally paid) for the asset.
When it comes to charitable giving, an often-overlooked strategy is to donate appreciated assets using a donor advised fund (DAF). A donor-advised fund is a private fund administered by a third party and created for the purpose of managing charitable donations on behalf of an organization, family, or individual. With a DAF, you can make charitable donations now and receive the tax deduction, but decide later which charities will receive money from your portion of the fund.
• Give the assets to family members. You can give up to $15,000 a year to as many individuals as you want tax-free. Using our example above, you and your spouse could each give $15,000 worth of an appreciated security to a family member each year for three years and then the remaining $10,000 during the fourth year.
Keep in mind the potential tax implications of this strategy on the recipient. If the gift is in cash, it could potentially push the recipient into a higher tax bracket. And if you gift shares of stock, the tax bill will be due on any gains once the asset is sold and the gains are realized. Be sure to discuss this with both your advisor and your tax professional to make the most of this type of gifting plan.
The details and logistics of selling and donating appreciated assets can get complicated. Give us a call at (803) 791-1111 or send us an email if you have questions about your specific situation.
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Investment Advisory Representatives offer advisory products and services through Longleaf Advisory Services, LLC, a Registered Investment Advisor.
171 Lott Court
West Columbia, SC 29169
All Rights Reserved | Longleaf Advisors
Investment Advisory Representatives offer advisory products and services through Longleaf Advisory Services, LLC, a Registered Investment Advisor.