PROS AND CONS OF DIRECTLY OWNED ASSETS

Where you own your assets is as important as what asset classes you own. Certain investments have tax benefits that may be lost if owned in a retirement plan, whereas there are distinct advantages to holding directly owned investments.

There are many advantages to holding directly owned assets. There are also limitations. With directly owned investments, capital gains aren’t realized and taxable until the asset is sold or exchanged in a taxable transaction. For example, you hold 100 shares of Microsoft stock that you bought at $89 per share. The ups and downs of the stock price won’t affect your taxes until you decide to sell. Should you sell the stock at $85 per share, you will realize a $4-per-share capital loss. However, if you were to sell at $95 per share, then you would be taxed on a $6-per-share gain. Depending on how long you have owned the asset, you will be subject to capital gains taxes. If you held the stock for less than one year, the gain will be taxed as a short-term gain, which is at your ordinary income tax rate. However, if you held the stock more than one year prior to the sale, then the gain is taxed at the long-term capital gains rate, which, as of 2002, is at a 20-percent maximum. This 20-percent maximum is an advantage for all taxpayers who are in the higher tax brackets. For those in the lower brackets, the maximum long-term capital gains rate is 10 percent.

Another advantage to directly owned assets is called a “step-up” in basis at death. While the original cost is usually the starting point when calculating basis, when a directly owned capital asset, such as stock, is inherited, the value at the time of the owner’s death becomes the starting point. For instance, you inherit 1000 shares of Schering- Plough stock. The original cost basis for the stock is $20 per share. However, when you inherit it, the cost of the stock is $57 per share. You decide you will sell the stock at $60 per share, which you then do. Your gain on the stock is $3 per share, not $40 per share because of the step-up in basis.

If you were to sell your holdings for a loss, you would be able to use that capital loss on your taxes to offset any capital gains you may have had, plus offsetting some of your ordinary income. Up to $3000 of a capital loss may be used per year. Any unused portion of the loss may be carried over to subsequent years. Financial planning may help reduce your tax burden due to capital gains and you may be able to postpone or even avoid capital gains taxes through proper planning. The limitations of holding directly owned assets are fewer than the advantages. However, they should be considered just as seriously. Each year that you receive taxable interest and/or dividends on an investment, they are taxable to you. Likewise, any capital gains you receive are taxable. This is generally found with mutual funds through fund turnover that occurs throughout the year. At the end of each year, mutual fund companies are required to declare their dividends and capital gains, which are then passed on to the shareholders. You, the shareholder, receive a 1099-DIV form from the company and you must declare it on your tax forms. Also, capital gains may be triggered when your advisor rebalances your portfolio. Any selling or exchanging of an asset for a gain will be taxable to you on your taxes. Whether it’s a long-term or short-term gain depends on how long you have held the asset.