Tuesday, August 25, 2009

The Low-basis Stock Dilemma

The dilemma we face as taxable investors has big horns: if we hold on to our appreciated assets long enough we can die with them and create a new cost basis for our heirs, bypassing capital gains taxes. This horn leads investors to hold on to companies earning subpar returns holding out for the hope “good times” will return and justify the hold by avoiding tax erosion. Should we sell, pay taxes and then redeploy in an asset that does not meet our objectives we are stuck again and with 20 to 30 percent less? This issue drove many investors to invest in absolute return strategies aiming for minimal volatility and 1% monthly returns (which rapidly became 0.50% monthly returns). Taxes are maximized but downside seemed minimal which is more important - sort of like the devil you know is better than the one you don’t.

That didn’t work well either, as of last year investors that capitulated with this strategy in the last 24 months lost 50 to 80 percent of their capital and likely are hung with non-performing investments in long term lock-ups.

So what does a shrewd investor do? Structuring your holdings in partnerships can provide a great solution. Following estate planners’ main theme “live well and die poor,” developing investment partnerships between different family generations can allow for holdings to be managed for maximum tax efficiency and ultimately better returns.

Don’t allow tax consequences to drive your investment decision process, but it's OK for them to sit in the front seat with the business merits driving the deal.

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