How to ease rebalancing tax woes for clients

Register now

Many financial advisors rebalance clients’ portfolios periodically -- by selling assets that are over an investor’s predetermined allocation -- and buy what is under the allocation.

Buying low and selling high is likely to pay off, long term. However, selling what is high can lead to tax bills.

How can advisors follow a rebalancing plan yet avoid the tax crunch?

“To the extent I can, I put all equity exposure in retirement accounts,” says Ronya A. Corey, founding partner and senior vice president of wealth management at The Corey Group of Merrill Lynch in Washington. “Any gains taken in a retirement account are not taxable.”

With equities in retirement accounts, fixed-income assets may be held in clients’ taxable accounts, Corey says.

There typically is less turnover in fixed income than in equities, so rebalancing bonds in a taxable account might not be as taxing as rebalancing equities there, she says.


Not every client will hold all equities in retirement accounts, so rebalancing stocks in taxable accounts may be necessary.

Brent Robbs, a tax planning consultant in the wealth management department at Stifel Financial Corp. in St. Louis, suggests harvesting capital losses, which can reduce net gains, taxable income and adjusted gross income.

“Say a client must realize a $25,000 gain to properly rebalance a portfolio,” he says. “Prior to year-end, realizing losses totaling $15,000 will reduce the net gain to $10,000.”

If all losses in a calendar year exceed gains, up to $3,000 of losses can be deducted and larger losses can deliver future protection from taxes on realized gains.

Corey rebalances taxable accounts on a schedule that extends beyond 12 months, so any gains from sales of over-allocated assets can be classified as long-term.

“Long-term capital gains rates are preferable to short-term rates,” she says. “By rebalancing consistently -- every 13 months, for example -- only capital gains since the last rebalancing period are considered in the current sale.”


Clients who don’t have losses to offset gains might shift deductions into the year of the realized gains, Robbs says.

“Say a client anticipates a tax bill of $10,000 federal and $2,500 state,” he says.

“Making a $2,500 state estimated tax payment prior to year-end, rather than waiting until April of the following year, shifts that deduction forward to the current year, potentially reducing federal tax liability. However, this won’t help clients who are subject to the alternative minimum tax,” Robbs says.

Charitably minded individuals might consider donating a portion of the appreciated stock.

“Say a client wants to sell a stock that has a fair market value of $100,000, including a $25,000 gain. Before selling, this client can contribute $20,000 of the position to a donor-advised fund and sell the remaining $80,000,” Robbs says.

“Now the realized gain is $20,000, and the client will receive a $20,000 tax deduction,” he says. “This strategy fully negates the tax costs of rebalancing while helping favorite charities.”

Donald Jay Korn is a New York-based financial writer who contributes to On Wall Street and Financial Planning.

For reprint and licensing requests for this article, click here.
Tax planning Financial planning Banking 30 Days: Tax Planning 30 Days 30 Ways