Since about half of all stocks are down for the year, it's no wonder many portfolios are seeing red for the first time in a while. What should you do? Should you sell some of your long-term holdings that have tanked recently?
No. Turn off
and go back to the
Olympics instead. (The U.S. is kicking butt, by the way.)
Here are some tax-planning tactics you can use if your long-term holdings have temporarily tumbled.
But before you think about taxes, remember that selling securities should be primarily an investment decision. Don't sell a favorite holding just because of tax considerations.
Here's a reality check: If you bought
two years ago, you're up 105% and 254%, respectively, on these stocks. Regardless of what's been going on recently, that's nothing to balk at, particularly since the
is up just 37% over the same period.
When your stock rises that much, "you've got to expect to give some back," says Rande Spiegelman, a senior manager in
investment advisory services group in San Francisco. "So Intel's recent
earnings warning shouldn't be a life-changing event."
But you can take advantage of the markets' dips to remove assets from your estate so you won't owe taxes on them when you die. Here's how.
Give It Away
Now's a great time to transfer assets to another person. If the value of your assets has declined, the value of your gift will be less, too, and that means less chance of gift tax.
You can give up to $10,000 a year to any one person with no tax implications. If you are married, you and your spouse can give up to $20,000 to a single person in a single year.
If you give more than that, you will cut into your $675,000 lifetime unified gift and estate tax credit. That means if you're single, the first $675,000 of assets are not subject to estate taxes upon your death. (The credit will gradually increase to $1 million by 2006).
Your gift is made at its fair market value for tax purposes. Let's say you bought 1,000 shares of Intel at $7 in January 1996, and you want to give them to your child this year. Since it's now trading at $45, you'd be making a $45,000 gift, but you've removed $38,000 in appreciation from your estate. Assuming you and your spouse made this gift, only $25,000 would cut into your unified gift and estate tax exclusion. (Remember, a married couple gets a $20,000 freebie before the gift cuts into the exclusion.)
If you can give to a child who is at least 14 years old and in the 15% tax bracket, even better. Your teenager will be able to take advantage of the
new lower capital gains rates that begin on Jan. 1, 2001. As long as you held the assets at least five years, your youngster in the 15% tax bracket could sell them on Jan. 2, 2001 and owe only 8% capital gains tax, down from the current 10%.
If you do give assets to a minor, don't put them in his or her name, warns Seth Starr, a partner at
Frankel Loughran Starr & Vallone
, a financial advisory firm in New York. You don't want your kid spending all that money on tickets to
. Talk to your adviser about setting up a trust or a
Uniform Gifts to Minors Act
Generally, when you give away assets, the recipients get your original cost basis -- or what you paid for the shares -- and holding period. But if your cost basis is higher than the stock's current value, the recipient's basis becomes the fair market value, says Starr. So in this case, you might be better off selling the shares first, taking the loss on your tax return and then giving the cash away.
An Uncharitable Thought
There is no extra tax advantage to giving assets to charity when the stock is depressed. The lower the value of the gift, the smaller your
charitable deduction. So wait until the stock goes up again, if you can.
On the Estate Side
More extensive estate planning would involve establishing a grantor retained annuity trust, or GRAT, or family limited partnerships, or FLP.
GRAT, you essentially are loaning yourself money. You transfer your stock into an annuity and pay yourself back with interest. Any additional earnings that your investments make above that interest rate will be passed on to your beneficiaries without estate or gift tax.
You will owe gift tax on the value of the stock transferred to the GRAT. So you risk paying gift tax on the present value of assets that keep tanking, says Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. "A GRAT is only good if you think the stock is going to come back."
FLP, the assets you give are discounted -- up to 20% potentially -- so you'll pay less gift tax upfront. Then you can give pieces of the partnership to your heirs. There's less risk here of the value of the FLP falling too low, because you're starting off with a discount, says Nissenbaum.
Just be aware that the
Internal Revenue Service
is cracking down on FLPs set up with marketable securities. Because FLPs were created mainly for family businesses, you may run the risk of an audit. But if you have the stomach for it, it can be an excellent device.
If you entered the frenzied tech arena a bit late, say, at the end of March, your holdings are no doubt in the toilet. Intel's down around 33%, Cisco has sunk almost 25% and
has dropped 39%. Talk about bad timing. Fortunately, you have a few options to make your tax situation look prettier, and we've discussed these
Sell your position at a loss, wait 31 days, then buy it back. The
wash-sale rule requires a 30-day wait before you can buy back the same security, or the tax loss will be disallowed. If you wait, you'll be able to claim that loss on your tax return while only being out of the position for 30 days. You do risk the stock popping back up before your repurchase, though.
If you have extra cash around, and you're worried about missing a big upward move, double up your position instead. That is, go out and buy more.
Let's say you bought 100 shares of Intel at $70, and you think it'll bounce back. Buy another 100 shares at its current price, $45. Wait the required 30 days and sell the original $70 Intel shares. You will have now generated a tax loss that you can use to offset future capital gains. The best part: You're still holding the same number of shares, but at a lower cost basis.
If you still feel the need to sell, consider selling your holdings a little at a time to minimize your annual capital gains hit, suggests Nissenbaum.
But before you sell, think back to why you bought the stock in the first place before you do anything irrational.
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TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.