Financial Insights

Time to Rebalance Your Portfolio

Eight years into a bull market and with stocks at record highs now is an opportune time for investors to consider a charitable rebalance of their portfolios. As bull markets mature, portfolios may become over-weighted with equities, increasing an investor’s vulnerability to stock market corrections. For example, a portfolio comprised of 60% equities and 40% fixed income at the start of the current bull market in 2009, could easily now have 75% of its overall value represented by equities because of appreciated stock values. The level of the S&P 500 has more than tripled since the bottom of the market in 2009.

Reducing exposure to stocks in a taxable investment account typically means selling appreciated positions, which generally triggers a capital gains tax liability. That’s where charitable giving can help: donating to charity can be a great way to support the causes you care about while minimizing a prospective tax hit.

When giving to charities cash is not king.  Cash is often the most expensive asset to give to charity because in most cases, the donor will have incurred taxable income to free up cash to give.  Despite this “cost to give”, close to 90% of high-net-worth households who make charitable donations do so with cash.  By writing a check (cash) your donation misses an opportunity to give up to 23.8% more to charity without any additional cost to the donor.**

Here’s how to do it: instead of selling long-term appreciated assets (owned for more than 12 months), and donating the proceeds to charity, investors can donate the assets directly to charity. That gives them a double benefit: they are generally eligible to claim a charitable deduction for the full fair market value (FMV) of the asset and can potentially eliminate up to the 23.8% capital gains tax they would have otherwise incurred on the sale.

Consider the tax difference in making a charitable donation of $50,000 in stock with $30,000 of unrealized capital gains, as opposed to selling the stock first and then donating the cash proceeds.

If an investor sells the stock, they’d have to pay about $7,140 in tax on the $30,000 gain (based on the 20% capital gains tax and 3.8% Medicare surcharge). That leaves $42,860 to give to charity. While saving $16,973 in income tax thanks to the charitable deduction of $42,860, the ultimate tax benefit to the investor is just $9,833 after subtracting the capital gains tax paid.**

Now consider the simpler approach of donating the $50,000 in stock. In that case, there’s no capital gains tax. Instead, there’s a charitable deduction for the full $50,000 FMV of the stock and a potential tax savings of $19,800—more than twice as much as with the cash gift. Importantly, the full $50,000, undiminished by capital gains taxes, would be available for charitable purposes.

The best investments to donate are usually those with the most unrealized long-term capital gains. Donations can be made using a wide range of asset classes, from common stock to bitcoin to non-publicly traded assets such as private stock. With private stock, an investor could be facing a huge capital gains tax bill because these assets generally have very low or even zero cost basis.

The impact of possible future tax reform on charitable deductions is unclear. If tax reform leads to fewer or lower deductions and/or doubling the standard deduction, charitable rebalancing would be a particularly important strategy to consider in 2017. For a taxpayer currently itemizing their deductions, taking a larger standard deduction may become more attractive, eliminating the ability to claim the charitable deduction and all the associated benefits, like charitable rebalancing. This uncertainty, combined with today’s bull market make it an excellent time to consider the tax advantages of charitable donations before year-end.

*This assumes all realized gains are subject to the maximum federal long-term capital gains tax rate of 20% and the Medicare surtax of 3.8%, and that the donor originally planned to sell the stock and contribute the net proceeds (less the capital gains tax and Medicare surtax) to charity. Does not include state taxes, so additional tax savings on top of federal are possible, depending on the donor’s state of residence.
** This example assumes a married couple, filing jointly in the 39.6% federal income tax bracket, and a fully deductible donation at fair market value to a qualified public charity. It does not take into account state or local taxes, the alternative minimum tax, or limitations on deductions for taxpayers in higher income brackets. The charitable deduction is only available at the federal level if you itemize deductions. Charitable contributions of capital gains property held for more than one year are usually deductible at fair market value. Deductions for capital gains property held for one year or less are usually limited to cost basis. This is a hypothetical example for illustrative purposes only. Results will vary, depending on an individual’s tax situation.
Shared with permission from Fidelity Investments

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.


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