Tax Harvest Myths: Capital gains is the only measure that matters when transitioning taxable accounts

Avatar photo by Swati Bairathi, Chief Product Officer

Why our platform references specific tax liability and not just realized gains? 

Our platform, and indeed our holistic approach, is based on a philosophy of usability. While the engine that drives our tax-loss harvesting methodology is highly sophisticated, ease of use and ease of understanding are integral to everything we do. 

Taking a portfolio from where it was to where it needs to be invariably involves potentially selling legacy positions and buying new ones. Typically, this means realizing gains and generating sometimes hefty tax bills. But on 55ip’s platform this transition is not an “all or nothing” proposition. The continuum between “optimal portfolio” and “optimal tax impact” can be effectively balanced for each individual use case based on the portfolio-specific tax profile, and each investor’s preference and effective capital gains rate. 

For illustrative purposes only
Source: 55ip

In our sample portfolio the investor and advisor have choices between the two extreme positions. The client could transition 38% of the legacy portfolio without potentially generating any tax liability at all (the first column.) Or at the other end of the spectrum, the client could transition 100% of the legacy portfolio but generate an estimated tax liability of $61,661 (the third column.) For many investors, the middle ground may be their preferred solution, at least initially. 

An intuitive user experience that helps drive meaningful client conversations 

Our tool allows advisors to quickly evaluate both ends of the transition spectrum as well as to customize a specific transition based on those end values. Subsequent transitions can easily be made over time to leverage market action and take advantage of annual ordinary income deductibility limits. Advisors want to create a customized experience specific to their client’s requirements, and we see this in almost every industry. For financial advisors to deliver this customized experience at scale, they will need to reduce the frictions in their workflow with automation. Tax management is a good place to start because by definition, taxes are personalized. 

Importantly, our optimization tool displays and highlights “Estimated tax liability” in the first row and “Realized Gain/Loss” in the last. We do this for one simple reason – it’s how investors think. When it comes to tax management, advisors think about things like realized and unrealized capital gains, tax lots, and cost basis, while the end investor simply thinks about what they owe to Uncle Sam. It’s perhaps subtle but, we think, an important differentiator. Of course, most specific examples of good user experience are, when looked at individually, subtle. 

In our conversations with advisors and their clients, we’ve found that the specific dollar cost of the transition, regardless of how much of the portfolio is transitioned, is the critical metric for making informed decisions. Realized gains are of course the first step in calculating this figure, but it’s the tax bill itself that’s the critical decision point. As tax-smart investors are fond of saying, it’s not what you make, it’s what you keep. It’s one of many ways 55ip continues to prioritize and embed client needs and advisor usability into our platform. 

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