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Investing Specialists

Tax Moves That Could Save You a Bundle

Readers discuss how they used the last bear market to their tax advantage, the role of donor-advised funds, and more.

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For most investors, a bear market like the one that pummeled stocks in 2008 and early 2009 is just about the last thing they ever want to see again. But proving that, even in investing, every cloud does have a silver lining, some investors were able to take advantage of that short-term drop in stock prices by making tax moves that would later pay off in a big way.

Morningstar.com readers shared these and other helpful tax tips in response to a question posted to our Personal Finance discussion board last week. On the heels of an earlier question asking readers to share their worst investing-related tax blunders, readers this time shared their best tax moves. Take a look and you might just pick up some tax-savvy pointers, or at least some ideas to get you thinking about how to manage the impact of taxes on your own portfolio. You can read the full conversation by clicking here

'Don't Look a Gift Bear in the Mouth'
Many readers mentioned widely known tax tips, such as saving for retirement in a tax-advantaged account like an IRA or 401(k). For example, treasur2's top tax tip was "saving when I couldn't 'afford' it in a 401(k)."

But one of the most frequently mentioned, and perhaps less well-known, tips was about tax-loss harvesting, specifically related to the most recent bear market. The basic idea behind tax-loss harvesting is to bank capital losses from the sale of securities that have lost value and later using them to offset gains. Several users said they've been able to put this strategy to good use.

"During the 2008-09 downturn, I was very disciplined about 'harvesting' my tax losses in the equity markets and reinvesting in similar but not identical funds or strategies," recalled JupiterMars. "After the recovery, that enabled me to shelter some larger real estate gains. Today I am left with significant unrealized capital gains on equities but I have lots of control over the timing to minimize the tax impact. ...  Nobody loves a down market, but the lesson I learned was: 'don't look a gift bear in the mouth.'"  

"In early 2009, I harvested tax losses by selling stock mutual funds with losses and buying other stock funds," wrote randy_s. "Tax losses are still being carried forward to this day. Being retired and temporarily in a very low tax bracket, I was able to convert assets in regular IRAs to a Roth IRA for 3-4 years without paying extra tax on the federal level."

Another reader making the best of a bad market was Tomas47, who said that the 2008 market crash "allowed me to do a major restructuring of our portfolio without incurring capital gains tax by offsetting the gains from some very long-term holdings with losses in other holdings. I did not change the overall asset allocation but was able to finally get all the least tax-friendly holdings into my IRA and the most-friendly into taxable accounts."

For ConeheadMC, it was an earlier bear market that provided a tax opportunity. His or her best tax move was "converting my regular IRAs to Roth IRAs shortly after the tech bear market of 2000-01. To encourage conversions you could do a multiyear spread of the tax liability then. I am in a higher tax bracket now than when I converted and will likely remain in a higher tax bracket when I retire. So the tax-free income stream from the Roth IRA withdrawals will probably work out to the single biggest tax savings of my investing life."

'Almost As Good As a Roth"
Some retired readers said they've been able to take advantage of the lower tax brackets they've fallen into now that they no longer receive a paycheck.

"Our best move was opening Roth IRAs when we could, funding them fully in every year we were eligible to do so, and then converting some of our Traditional IRA money to the Roths in retirement when our marginal tax rate has been low," wrote retiredgary.

Another retiree, duanej, said falling below the threshold for having to pay capital gains taxes has freed up his investing approach, including holding more long-term stock holdings in a taxable account.

"Under current tax laws one can potentially realize a lot of capital gains during retirement and pay no income tax; just stay out of the 25% bracket [for ordinary income]," he said. "Almost as good as a Roth IRA, and with no contribution limits or income restrictions."

Gatorbyter recommended a Roth conversion strategy for those new to retirement. "For early retirees, prior to pension income and/or Social Security income, process routine Roth conversions to an amount that will keep you at your [same] long-term tax bracket," the commenter suggested. "In other words, don't fall into the trap of paying low federal taxes during this period (due to low income) only to realize later that you will be subject to large RMDs when you are age 70 1/2. The key is to intelligently manage your tax liabilities throughout your retirement period."

Donor-Advised Funds and Other Tax Tools
Another popular topic of discussion among readers was donor-advised funds.

Yogibearbull said his best investment-related tax move was "funding my donor-advised charitable account with appreciated stocks and funds many years ago. I got immediate tax deductions at the time as well as avoided capital gain taxes."

Greybeard told a similar story, writing, "Some years ago I researched charitable trusts and found an attorney who established a CRUT [charitable remainder unitrust]. I funded it with decades of appreciated stock from my employer's stock purchase plan and some other appreciated investments which would have been painful to sell outright. Now the funds appreciate (more or less) in a sheltered account, and I can manage the portfolio depending on which way the financial winds blow." (For more on how donor-advised funds work, see this article by Morningstar's Christine Benz.)

Other readers mentioned various other approaches to keeping investment-related taxes in check.

Beanclub told of using a tax-friendly strategy to help his or her daughter pay for college, writing, "The good: gifted IPO shares of  MasterCard (MA) to my daughter during her college years to pay her tuition. She sold as needed with little or no capital gains tax. The bad: should have kept the shares and taken out a home equity line [of credit] at 3%!"

Gtoerr mentioned paying state taxes early one year in order to save on taxes at the federal level.

"When one investment resulted in a sudden windfall, I paid my state income taxes in December rather than waiting until April," gtoerr wrote. "This allowed me to deduct that larger state payment on my federal return for the windfall year rather than the year after, thus offsetting (somewhat) the spike in my federal taxes."

In a few cases, readers said that doing extra research on their own had helped them become more tax-aware.

"We figured out, after our investment advisors had missed it for years, that we were eligible for spousal and individual Roth accounts," said danielle. "They thought we weren't eligible due to being over the income limits, but much of our income was nontaxable insurance benefits. Oops."

Reader Hyrground said one of his smartest tax moves was "doing our own taxes in order to see and understand the tax consequences of each of our investment (and non-investment) related decisions."

Of course, not everyone is as tax-conscious as the readers we've just mentioned. Others prefer to focus on getting investing right and not to worry about the tax bite.

"In all honesty, 99-plus% of my investment decisions are not based on taxes," wrote BMWLover. "The only time it may come into play is when I'm right at the one-year holding point and I want to be sure my gains qualify as long-term gains rather than short-term. Other than that, I focus purely on the investments and let the taxes fall where they may."

Some comments have been edited for clarity and brevity.

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Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.