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Highly Appreciated Investment and Capital Gains Strategy


Investors are often faced with having to take a potential capital gain on a highly appreciate stock, ETF or mutual fund investment when that investment begins to underperform and increases the risk in a taxable portfolio. This phenomenon often creates conflicting emotions as many investors seek to minimize tax or avoid them all together. Recently there are many examples of this due to a long bull market that appears to be entering its later stages and companies such as Facebook where headline issues have caused the stock to pull back significantly. The first instinct often is to sell the investment to reduce the risk and exposure. However, the realization that a large tax bill will accompany this transaction often will make an investor hesitate or not act at all. So, what can one do or how should one go about managing this issue.

First the good news is that paying capital gains tax means the investor has made money and that is ultimately the goal. In these situations, the tax treatment is typically long-term capital gains tax which is taxed at substantially lower rates than short term capital gains. A couple of ways to reduce the potential tax liability is to look for other positions to sell that may be at a loss either long term or short term. Those losses will be netted against gains and hopefully reduce tax liability. Carry over losses may also be applied if the investor has them. 

Other strategies are to donate the investment to a charity or donor advised fund and take a charitable contribution to reduce taxation and eliminate the investment from one’s portfolio. The investor in this case does not have the asset for personal use or the proceeds from a sale to use but they will get a tax deduction. The tax deduction will be for the Fair Market Value of the stock. The limitation on the amount of the deduction taken in the year donated will be 30% of Adjusted Gross Income (AGI) for a public charity or 20% of AGI for a private charity. Any amount left over can be carried forward for 5 years.

Two other strategies are to set up a capital gains budget by selling enough shares equaling an amount of capital gains the investor is willing to absorb and/or an amount of capital gains that can be absorbed by the investors current capital gains bracket without pushing them into the next higher tax bracket. Be careful to also consider the 3.8% Medicare surtax triggers at the higher income tax bracket levels. Lastly a Staggered or Staged Selling strategy may be used. This is where the investor agrees to sell at certain predetermined prices with a commitment from the investor to do so ahead of time regardless of market conditions. This is a more disciplined approach that requires the investor to understand that future growth in the investment can be lost in order to reduce potential tax burden's and further diversify the portfolio in order to reduce risk.



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