Displaying items by tag: capital gains

When it comes to making clients happy, there is no substitute for a wide variety of offerings given that everyone has their own unique circumstances, priorities, risk tolerance levels, and goals. Ironically, the recent trend in wealth management over the past couple of decades has been the opposite with the rise of ubiquitous 60/40 portfolios and passive strategies.

However, the introduction and ongoing proliferation of direct indexing is an antidote and presents an opportunity for savvy advisors. In essence, direct indexing allows investors to recreate an index within a separately managed account by owning the actual individual stocks. This is now possible due to technology, lower commissions, and fractionalization of shares. 

The major benefit for clients and advisors is that these indexes can be customized as little or as much as clients desire. Thus, it retains the pros of passive investing, while allowing for personalization and the potential to harvest tax losses. 

For example, investors who have strong beliefs about climate change may look to eschew companies who are responsible for emissions or the production of fossil fuels. Instead, they may want to overweight stocks with high ESG scores. With direct indexing, an advisor can theoretically create custom products for each client, leading to greater satisfaction and success for both parties.

Finsum: Advisors should get comfortable with direct indexing given that it allows for personalized products that are more likely to appeal to an investor. 

Buying and selling real estate properties can be quite lucrative for investors, but incurring capital gains taxes can weaken profits. What if there were ways to limit capital gains taxes on properties? In a recent article in SmartAsset, Ashley Kilroy suggested a few different ways for investors to limit their capital gains on real estate properties. The first to employ tax-deferred funds. For instance, you don't have to buy real estate with cash. You can use your IRA or 401(k). By depositing profits in your account, it allows your money to grow tax-free. Second, you can make the property your primary residence. The IRS exempts primary residence sales from capital gains taxes up to $500,000 for married filers and $250,000 for single filers. Third, employing tax-loss harvesting can help you avoid capital gains, assuming you are selling one property for a loss and another for a profit. Fourth, utilizing the 1031 Exchange allows you to use the income from the sale of one property to purchase another property of equal or greater value. In this scenario, you wouldn’t have to pay taxes on prior depreciation deductions. Fifth, the IRS allows rental property owners to deduct an annual depreciation amount from their income. Sixth, you can deduct the costs of managing property through itemized deductions, which lowers your tax burden. Seventh, improving your property boosts your property basis which can shrink your capital gains taxes and increase your property value.

Finsum:A recent article on SmartAsset provided seven different ways investors can limit their capital gains taxes on their real estate properties.

President Biden’s 2023 federal budget levy’s a new ultra-wealthy tax that would apply 20% total income tax on those with a net worth of more than $100 million. Notably in the deal, it opens the window to tax unrealized capital gains or any asset growth. The bill is expected to meet a brick wall in congress however as even moderate Dems will have a difficult time supporting it. Biden’s selling point is the expected $360 billion in payments toward the deficit in the next decade. However, the senate proposed a very similar bill last year that was shut down by congress.

Finsum: Taxing unrealized gains is a slippery slope, and hopefully would never trickle down to different wealth classes.

Dan Egan, VP of behavioral finance at Betterment, suggests that personality types play a critical role in invstmet decisions such as tax-loss harvesting. Investors' neuroticism and emotional intelligence are linked to the strategies they pursue and their behavior can be predictable. For example, investors with low neuroticism may not care too much about the day-to-day movements in their portfolio they don’t take advantage of tax-loss strategies for their accounts. Betterment offers robo-advisors that will offset these types of forecastable decisions in a portfolio.

Finsum: Investors' own bias can lead them to shut the doors on opportunities that could save them lots of money.

The longer equity portfolios experience growth over time the fewer the opportunities there are to realize the losses and take advantage. Actually quant fund AQR called these appreciated portfolio’s a ‘liability’ for tax purposes. One interesting thing they find is that tax preferred passive equity and direct indexing can develop unrealized gains rapidly. It takes only 3 years for direct indexing to have unrealized gains hit 50% of the portfolio value and 5 years for a tax preferred passive strategy. AQR offers an alternative approach, ‘enhanced indexing’ which is a tax-loss strategy they developed that can help investors. If a direct-indexing strategy already has large unrealized gains it is hard to catch up, but the enhanced indexing strategy can still generate losses for tax purposes. Enhanced indexing is the preferred option when a portfolio is already heavily appreciated.

Finsum: Direct indexing and enhanced indexing are both novel strategies in maintaining an ETF like strategy while taking advantage of tax-loss harvesting.