It’s hard to believe, but the end of 2019 is quickly approaching. The end of the year brings focus to year-end tax planning.

One of the first steps is ensuring applicable required minimum distributions (RMDs) are made to avoid steep IRS penalties.

There also tends to be a frenzy of year-end charitable giving that occurs for many individuals. Ensuring gifting occurs in the most tax-efficient manner can add a lot of value. Common strategies include making qualified charitable distributions (QCDs) from IRAs, gifting appreciated stock, or bunching gifts into one tax year.

Special attention should also be paid to reducing taxes from a capital gains perspective. Ideally an attempt should be made to minimize capital gains throughout the year. One method for achieving this is placing tax-efficient assets, such as exchange-traded funds (ETFs), within taxable accounts while placing tax-inefficient assets, such as actively managed portfolios with some degree of turnover, in qualified accounts not subject to capital gains.

When evaluating mutual funds for inclusion within portfolios, avoiding funds with a track record of significant turnover can help boost after-tax returns. For taxable accounts, however, turnover and resulting capital gains will always be a reality. Whether the turnover comes from regular rebalancing, accommodating distributions, or repositioning your portfolio to enhance returns, by the end of the year most portfolios have some level of realized capital gains.

Two specific strategies should be used to help mitigate these capital gains:

1. Actively harvesting losses within portfolios to offset realized gains.
2. Thoughtfully selling mutual funds prior to capital gain distributions, when appropriate.

The first strategy is by far the most common and straight forward: selling a position at a loss directly offsets any realized gains for the year, reducing the associated tax liability of those gains. Often the proceeds from these sales are reinvested immediately in the market, or are invested back into the same security after 30 days to avoid wash sales.

The second strategy is slightly more complex and requires significant attention to detail by wealth management professionals. Mutual funds accumulate capital gains that have been realized throughout the year and make distributions of those capital gains in one final distribution, typically made in November or December for most fund companies. Any holder of record as of the “ex-dividend” date will be forced to receive any applicable capital gain payout from the mutual fund.

In certain circumstances, it may be appropriate to sell the underlying mutual fund prior to the ex-dividend date in an effort to avoid the year-end capital gain distribution. This may be particularly advantageous in a year when the mutual fund has an unusually high level of turnover.

It should be noted that by selling the mutual fund any unrealized capital gains from price appreciation become realized, so the embedded gain must be less than the year-end distribution for this strategy to make sense. Special attention also needs to be paid to the holding period for the fund and wash sale rules when reinvesting proceeds.

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