Why Market Volatility Can Reduce Tax Transition Costs

Published on

April 9, 2020

With market volatility comes a silver lining – periods of market downturn may be the most cost-effective time to transition assets. Lower stock prices result in lower capital gains on sale, and, as a result, it becomes much less expensive to shift client assets. For clients who are interested in values-based investing, but may have previously been deterred by the tax cost of moving an equity portfolio with significant built-in gain, now may be a good time to reevaluate their transition costs.

The magnitude of tax transition costs, and how much those costs have fallen in recent weeks, can often depend on how long ago the transitioned stocks were purchased. Consider a client who holds US equities that were purchased in 2015. During 2015, the average closing price of SPY, an ETF that tracks the S&P 500, was $206.19. Prior to the current market declines, SPY hit a closing high of $338.34 on February 19, 2020. A sale of $100,000 of SPY that had been purchased at that 2015 average closing price would have resulted in just over $39,000 of capital gain if sold at the February 19, 2020 closing price.  At quarter-end, on March 31, 2020, SPY closed at $257.75. From February 19 to March 31, the capital gain that would have been recognized from a sale of $100,000 of SPY, purchased at that same 2015 average closing price, was cut almost in half to just over $20,000. 

To put the example in the context of clients’ taxable accounts–for a client paying federal long-term capital gains tax at an 18.8% rate, this would amount to a federal tax of a bit under $3,800 per $100,000 of SPY sold on March 31, 2020, as compared to over $7,300 per $100,000 of SPY, if sold at the closing price on February 19, 2020.

For stocks purchased over the last decade, the reduction in tax transition costs due to the recent market decline has been significant. This savings generally increases for stocks purchased in the past few years. In fact, for stock purchased in 2018 and 2019, discounts in tax transition costs exceed 100% of what the tax transition cost would have been in mid-February. As of March 31, 2020, a share of SPY purchased at the average closing price during 2018 or 2019 actually had a built-in loss. Far from having to pay the tax transition costs that may have come to seem inevitable during the bull market of the past decade, clients who purchased equities more recently may actually be able to recognize a tax-transition benefit, by selling out of equity holdings that are at a loss in order to fund an SMA.

It’s hard to gauge how long the current downturn will last, or whether it will get worse before it gets better. However, as this analysis demonstrates, a market downturn can significantly reduce the costs of account transitions. And while market volatility can cause uncertainty and unease, there are strategies that advisors can undertake to provide value to their clients.

Get in touch to learn more at institutional@openinvest.com. 

Investment in securities involves the risk of loss. Past performance is no guarantee of future returns. One cannot invest directly in an Index. Any opinions, estimates and forecasts offered in this document constitute judgment as of the date of the materials and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information contained in this document to be reliable but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and it is not intended to provide and should not be relied on for investment, accounting, legal or tax advice.