The bull run continues. The Dow Jones has risen 292% from the abyss in 2009, and it’s now the longest running bull market in stock market history. The move has produced some monster capital gains and it’s possible you may be sitting on a few stocks with large profits. What can you do if you own a portfolio full of profits?
Let’s look at a few ideas you can employ if you own stocks or funds with large capital gains in a taxable account.
Hold. If you have gains, you don’t have to do anything. Holding on to existing positions allows you to defer gains and taxes for as long as you want. If you still believe in your holdings, let your profits run.
Family. You can give your shares to your children, but you won’t get a tax deduction. It will reduce your estate and increase theirs. Your children will inherit your cost basis.
Charity. Donating your shares directly to a charity will allow you to deduct the contribution from your taxes at fair market value. The charity will benefit because they can sell your shares free of taxation and use the proceeds to fund their cause.
Donor Advised Fund (DAF). A Donor Advised Fund allows you to transfer appreciated shares to this instrument. Once inside the DAF, you can sell your existing shares and purchase new investments without realizing a capital gain. You can deduct the contribution from your taxes and then distribute the proceeds to charities you support. The deduction from your taxes occurs in the year of contribution, not in the year of distribution. You don’t have to distribute the proceeds immediately, so if you’re not sure which charities to support you can defer payment until you identify organizations you want to help. For example, if you transfer $100,000 worth of Amazon stock to your Donor Advised Fund you can sell it and reinvest the proceeds, and then send a portion of the money to your favorite charity. The funds inside your DAF will continue to grow tax-free.
Call Options. A call option replacement strategy allows you to sell your equity shares and purchase a corresponding share amount in the form of a call option. The ratio is 100 shares to 1 option. If you own 1,000 shares, you can purchase 10 option contracts. This strategy allows you to sell your stock position but retain ownership in the company at a reduced amount. For example, 1,000 shares of Amazon is currently worth $1.86 million. The January 2019 $1,860 strike price has a current price of $162 per contract, so 10 contracts costs $162,000 (10 x 100 x 162). The contract value is about 10% of the market value of the common stock. If you sold your shares, you can use a small percentage of the proceeds to buy the option and diversify the remainder. The downside for this strategy is that you’ll pay tax when you sell your shares. Another disadvantage is the call option has a finite life, it will expire on January 18, 2019. If Amazon is trading above $1,860 at the time of expiration, the call option will finish in the money and you can take your gains. If Amazon is trading below $1,860, your option will expire worthless and you’ll lose 100% of your money.
Put Options. If you want to hold your shares, but you’re concerned about a drop in the price, you can purchase a put option. A put option will increase in value when a stock falls. It’s short term insurance against a market decline. This strategy allows you to retain your stock, but at a price. Insuring your position will get expensive, especially if you repeat the process a few times a year. For example, the January 2019 $1,860 strike price is currently $135. Protecting 1,000 shares will cost you $135,000. If Amazon falls below the $1,860 strike price at expiration, you’ll make money. If Amazon closes above $1,860, you’ll lose 100% of your proceeds.
Charitable Remainder Trust (CRT). This trust allows you to transfer your shares to a CRT, sell your holdings, and receive income from the proceeds. At your death the remainder of the trust is delivered to a pre-determined charity. The stock, once transferred, can be sold free of taxation and then you can reinvest the proceeds into a diversified portfolio of stocks or funds. Your contribution to the trust qualifies for a charitable deduction. The amount of income you may receive from the trust is between 5% and 8% of the portfolio value.
Exchange Fund. As the name implies, you exchange your current shares into a fund to receive shares in a basket of stocks. This will allow you to defer your gains. The minimum is steep, and you’re required to hold the fund for several years. In addition, 20% of the fund assets must be held in non-investment assets like real estate which may hinder your liquidity efforts. According to a Forbes article on exchange funds, the minimum investment for some funds is $5 million with a required holding period of seven years. This strategy is best suited for individuals who own concentrated stock positions.
Private Annuity. This is a popular strategy that can benefit you and your favorite charity. The private annuity works well with colleges and universities. If you donate your stock to your alma mater, they can establish a private annuity for you, so you can receive income for life. Your alma mater can sell the stock free of taxation and use it to fund their operations. You’ll get a deduction and an income stream.
The only difference between death and taxes is that death doesn’t get worse every time Congress meets. ~ Will Rogers
July 25, 2018
Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. Options involve risk and are not suitable for every investor. Please consult your CPA or tax advisor before implementing any of these strategies to see if it makes sense for your situation.