Unrealized capital gains on stocks/mutual funds

[OtisMozzetti]

My client has a rather large dollar amount of unrealized gains on stocks about half of which are held through mutual funds. The client is age 62 and retired. If the gains of about 1 million were all realized even a portion each year, then various higher taxes including the alt. min. tax would kick in.

The client does intend to take advantage of the 0% rate on a certain portion of capital gains. The 15% and 5% rates on capital gains are scheduled to go up after 2010, and might go up even sooner given political trends.

The client doesn't have any heirs that he wants to inherit the assets with a stepped up basis.

How should the client go about deciding how much of the gains to realize each year?

[BOB W]

My client has a rather large dollar amount of unrealized gains on stocks about half of which are held through mutual funds. The client is age 62 and retired. If the gains of about 1 million were all realized even a portion each year, then various higher taxes including the alt. min. tax would kick in.

The client does intend to take advantage of the 0% rate on a certain portion of capital gains. The 15% and 5% rates on capital gains are scheduled to go up after 2010, and might go up even sooner given political trends.

The client doesn't have any heirs that he wants to inherit the assets with a stepped up basis.

How should the client go about deciding how much of the gains to realize each year?

One way is to make a charitable contribution of appreciated stocks. A second way is to gift the stocks to me, I'll be glad to pay the taxes on it.....

[JohnH]

Tell your client I'm drawing up papers today for him to adopt me and I'lll send them to him as soon as you give me his address. Then I'll have several suggestions on how to handle this problem he has.

[JoshinNC]

Charitable Remainder Trust

My client has a rather large dollar amount of unrealized gains on stocks about half of which are held through mutual funds. The client is age 62 and retired. If the gains of about 1 million were all realized even a portion each year, then various higher taxes including the alt. min. tax would kick in.

The client does intend to take advantage of the 0% rate on a certain portion of capital gains. The 15% and 5% rates on capital gains are scheduled to go up after 2010, and might go up even sooner given political trends.

The client doesn't have any heirs that he wants to inherit the assets with a stepped up basis.

How should the client go about deciding how much of the gains to realize each year?

Google it and then come back here with your questions.

[veritas]

Another possible option

If he has not sold shares before in a mutual fund you can use specific identification. He may have some recent purchases which can be sold specifically at a loss and sell other shares at a gain.

Managed funds use this method to control capital gains.

[Roland Slugg]

If your client's taxable income is below the upper limit of the 15% regular tax bracket, he should definitely sell enough stocks to take full advantage of the 0% tax rate on net LTCGs in 2008 (and, unless changed by Congress) in 2009 and 2010. If he has stocks with unrealized losses that he would like to sell, he can do that and than sell additional stocks at gains to offset those losses. This strategy, of course, may be used in any year ... not just this year.

If he's worried about tax rates on LTCGs being increased in 2011 (and perhaps as soon as 2009), he may wish to sell enough LTCG holdings this year so as to reach the crossover point where his total regular tax exactly equals his AMT. You should be able to calculate this point with your tax prep software, and the correctness of your projections will depend in large part on your ability to accurately project your client's income and deductions. For some taxpayers a high degree of accuracy is possible; for others projections are subject to significant variation.

If your client has started receiving Social Security benefits, don't forget to take them into account.

[JoshinNC]

ETF's use the following strategy

Let's say an ETF owns 1000 shares of IBM with a value of $5000 and a cost basis of $2500. If they sell the shares they have a gain of $2500, which has to be reported to the shareholders. To get around this the ETF goes to Goldman Sachs or some other broker and trades their 1000 shares of IBM for 500 shares of Dell (assume value of $100 per share, or $5000 for the lot). This qualifies as a like kind exchange and there is not gain to report.

I learned this over the weekend during my annual securities compliance conference. Maybe your client could go to his broker and see if they could arrange a similar "trade".

[Burke]

Since when are stock sales subject to 1031 exchange rules?

[jimmcg]

There are certain types of property which are by statute excluded from 1031 treatment. Stock, bonds, and notes are some of these types. Please enlighten us as to what Code Section you are referring to that permits this.

[JoshinNC]

I wouldn't be able to provide that because I don't do it in my client's accounts

There are certain types of property which are by statute excluded from 1031 treatment. Stock, bonds, and notes are some of these types. Please enlighten us as to what Code Section you are referring to that permits this.

I am simply relaying how Exchange Traded Funds get rid of appreciated shares without having to report a gain.

I'll call the presenter who shared this info and report back though.

[Snaggletooth]

Mutual Funds

If the gains of about 1 million were all realized even a portion each year, then various higher taxes including the alt. min. tax would kick in. The client does intend to take advantage of the 0% rate on a certain portion of capital gains.

Hi Otis, I'm trying to analyze your facts in order to bring out some previously undiscussed factors.

Gains of $1MM? Taking this literally, this tells us, that the gains ALONE are this much, meaning the actual size of the portfolio is much larger. Half of this tied up in mutual funds? If so, this takes away much of the control that can be exercised.

Assuming a huge portfolio in mutual funds, consider that they will pass through their capital gains and dividends to your client. Assume, for example, this mutual fund portfolio generates some $50,000 in 1099-DIV stuff (and that is certainly possible if these investments are as large as you indicate). If your client has any income whatsoever outside of these investments, your 0% rate is already seriously in jeopardy.

Once the general taxable income passes the 15% bracket, there is no provision to take 0% on a portion of the capital gains.

What about the rest of the stocks? If there is a portfolio this large with moderate diversification, it is overwhelmingly likely that one or more of them would have had a private equity buyout. Even large stocks are not safe - e.g. Chrysler Corp had a private equity buyout when Daimler sold them. If your client had one of these, it is certain that it would have occurred with a whopping gain. This results in even more dollars to add to his income, and the 0% bracket increasingly becomes a fading memory.

There are things that can be done, perhaps. Review these suggestions for what they are worth.

1) Reduce the income and the capital gains by selling the big losers. Remember that the ceiling of $3000 on capital losses is measured ONLY after first netting out against the gains, so a sufficient portfolio could give rise to very large losses. Look first at stocks purchased between 2005 and Sept of 2007. MOST stocks bought during this period are currently carrying losses. The objective is to create enough losses to apply against the 1099-DIVs coming from the mutual funds, and reduce income such that the 0% is available.

2) Act quickly, especially if you have mutual funds that can be sold at a loss. Many of the mutual funds distribute their income to shareholders only annually, or semi-annually. If you can sell these prior to the distribution, you will avoid the 1099-DIVs. Act quickly also on individual stocks, as they will probably be on the rise for the remainder of 2008.

Best wishes - Snag

[OtisMozzetti]

Thanks to all

This is to say thanks to all for your thoughts and your efforts.

The mutual funds which this client has do pay distributions with 1099-DIV. Virtually all of those distributions, though, are qualified dividends. It is my understanding that LTCG's and qualified dividends are set to pay the same 0% and 15% rates during 2008 and maybe (unless laws change) during 2009 and 2010.

[FEDUKE404]

Let's make a deal?

Since when are stock sales subject to 1031 exchange rules?

I second that question!

There's a huge difference between management of assets in an ETF and securities owned by a (very rich) individual stockholder.

(Reminds me of the "surprise" when a holder of various mutual funds never "took any money out" but was dumbfounded to see those Forms 1099-B appear after some selling/buying during the year!)

FE