When investors are considering funding a TaxM™ account, or really any new investment account, we often get the question: what’s the optimal way to handle concentrated positions of securities that have a low tax cost basis? In these types of situations, we believe it’s important to be mindful of the potential tax implications—and invest accordingly.
Concentrated holdings may consist of one large position (e.g., in a stock or ETF) or multiple positions (for example, five stocks, each with a 20% weight that are sitting on massive gains). At Neuberger Berman, we can help investors think through available options to minimize capital gains while transitioning to more diversified strategies.
As part of our approach, we consider the following five ideas and action steps.
- Review the entire investment portfolio for losses. A good place to start is to determine if there are losses that can be used to offset gains by writing off some, or all, of the gains that would be generated by transitioning the position. From our perspective, having a deep understanding of a client’s overall investments is important, since we can use this information to customize solutions. For instance, if there are $200,000 of losses available from a real estate transaction, we can transfer the concentrated securities that would generate a $200,000 gain (with, say, $500,000 in market value) to diversify the position.
- Add cash if available. Cash can be a powerful tool in reducing transition costs for the investor. When cash is transferred to an account with low cost basis, it can be used to “flush out” the securities with large gains—something that may be more tax-advantageous than sending the cash directly to, for example, a charity.
- Gift certain lots to charity. The investor may be able to gift securities to a charity or a Donor-Advised Fund1 at market value. We can conduct a detailed analysis to help determine the potential tax savings when transferring securities.
- Use a multiyear period to transition. Let’s say an investor has accounts worth $1 million, with $500,000 in unrealized gains. If the investor also has losses of $500,000 but can only use $250,000 of those losses to offset gains this year, the investor can transfer securities totaling $500,000 (to capitalize on the $250,000 in losses) now; then, next year, depending on losses in other parts of the investor’s portfolio (or in the new account that was just funded), the investor can transfer some or all of the remaining balance.
- Take an outright gain. In some instances, the simplest option of the five we’ve mentioned here may be to transition with a gain and diversify holdings by using a TaxM™ strategy. Even though the investor will incur taxes at the outset, our tax-aware strategies will look to generate tax losses over the lifetime of the account to offset future gains. The investor will reset its cost basis when transitioning and reduce its future tax liability through a combination of losses generated in the account and a reset of cost basis. This works if the investor is expecting its taxes to increase (e.g., by moving from Florida to New York, or entering a higher income bracket).
In sum, there are many ways to minimize the impact of taxes when moving to a diversified portfolio. In our view, the best solution will ultimately depend on a client’s objectives, risk tolerance and available losses to help offset gains. We welcome the opportunity to provide the personalized, detailed analysis necessary to help investors think through their available options.