Strategic Moves Can Help Lower Your Tax Bill

I have a very optimistic friend who is fond of saying, "If you're paying taxes, you're making money." It's a good reminder to focus on the positive, of course, but there are times when a big tax bill can feel crushing.

The good news is that there are some shrewd countermoves investors can make to maximize their portfolio's tax efficiency, allowing them hold on to more of their gains and income.

We checked in with Morningstar readers to see if they are considering any portfolio moves designed to help lessen their tax burden. Among the tax-savvy tips they shared was tax-loss selling, which allows investors to offset capital gains and up to $3,000 of ordinary income.

Readers also mentioned they plan to convert traditional IRAs to Roth IRAs (which, though not without short-term tax pain, can be a tax-friendly strategy for the long run). In a similar vein, some said they are paying increased attention to which types of accounts (taxable or tax-deferred) are best suited to particular investment types.

And finally, some respondents said they planned to make some charitable donations, which are a great way to help those in need while reducing your tax bill at the same time. (And there are smart ways to ensure that you are maximizing the tax savings you receive from charitable giving.)

The following is a summary of the responses. To read the full thread and weigh in yourself, click here.

Tax-Loss Selling Though it's never fun to lock in losses by selling when investments are down, you can use up to $3,000 of these so-called capital losses to offset other types of taxable income--including interest income paid out by your investments (capital gains or dividends) or even your salary.

But after a seven-plus-year bull market, good tax-loss-selling candidates may be hard to find. And in fact, many mutual funds with highly appreciated securities in their portfolios may be set to pay out capital gains and income distributions.

That said, many readers have managed to identify some worthy candidates in their portfolios, with some noting they are tying their tax-loss harvesting in with portfolio rebalancing.

win1177 said: "I bought a few individual stocks that have lost ground since their initial purchase, in order to 'average down' in several long-term dividend growth stocks. Then will sell the highest-cost-basis lots 31 days (or more) after the most recent purchase to capture the 'tax loss'."

"Since I have some net cap gains already booked, I may sell one or more CEF with a with large year-end distribution between ex-date and year-end to establish an offsetting loss in this tax year," said capecod.

Dermdoc said: "Maybe after I see the estimated cap gains I will decide to sell some shares of mutual funds or stocks that I have a small loss, then after 31 days I can buy back if I choose (wash-sale)." (For more on wash-sale rules, see this article.)

Likewise, BoomerGuy said: "Probably going to reap a few capital losses, mostly in bond funds, with the plan to buy most positions back in January ... maybe!!"

"I may take some capital losses," said atomiccab. "I have sold some individual stocks with large long-term capital gains this year. These individual stocks have become too large a part of my portfolio, which has become more diversified with index fund in the last 10 years."

On the other hand, modenesi said: "In December 2013 I was able to buy some bargain muni CEFs that others had sold for tax losses, and I still hold them. I'm standing ready to see if it happens again."

Converting Assets from a Traditional IRA to a Roth IRA Some readers are maximizing the long-term tax efficiency of their portfolios by converting from traditional IRAs to Roth IRAs. Of course, this will initially result in a tax hit, because you will pay taxes on the money converted when you perform the conversion. But it can be a tax-savvy investment vehicle for the long term, because withdrawals during retirement are tax-free. Also, assets held in Roth accounts are not subject to required minimum distributions. (For more on this, see this article.)

Further, doing a conversion during a market pullback can be advantageous from a tax perspective. Though the market is up around 6.6% for the year to date, it hasn't been a steady climb upward. If you were able to pick your spot wisely, your IRA balance may have been down a bit, and the tax hit associated with converting would have been lower.

For example, yogibearbull pointed out (quite rightly) that tax moves don't necessarily need to coincide with the end of the year. "I did Roth conversion when the market was down a lot in early February--this required filing estimated tax. Then, midyear, I sent additional estimated tax so that the total of my 2016 tax withholdings plus total estimated taxes would exceed my 2015 taxes. I may still make some minor tax-related adjustments in the next few weeks."

Intruder agrees: "Only possible move for me is whether to convert some depressed equities to a Roth IRA to maximize conversion opportunity."

"I continue to convert traditional IRA to Roth IRA … especially before I begin filing returns in a higher-income-tax state next year," said faroutwest.

"We are retired and too young for RMDs and so are able to manage our taxable income to keep taxes low," said retiredgary. "This year, as in every year before RMDs, we plan to convert as much from our traditional IRAs to our Roths as makes sense in terms of the impact on our marginal tax rate."

Asset Location A few readers said they were paying greater attention to "asset location," or the best type of account (either taxable or tax-deferred) to hold a specific type of security. Generally, holding high-tax-cost investment types in tax-deferred account types can reduce the drag of taxes on your portfolio, but there are some caveats. (See this article for more.)

"I am reducing the portion of my dividend-oriented stocks/funds in my taxable accounts and increasing dividend-payers in my tax deferred accounts," said MrMcDuck.

Dawgie said: "My wife and recently inherited some money, so we plan to fully fund both of our Roth IRAs by the end of the year. I also plan to retire at the end of January, so I'm trying to stash as much of my paychecks in my 401(k) as possible between now and then."

Charitable Donations Finally, a few readers said that charitable donations were a part of their tax-management strategy. As explained in this article, charitable strategies involving investments allow you to maximize the tax benefit of your donation, and tying those donations in with a portfolio maintenance regimen can also help improve your portfolio's risk/reward potential.

Javajoe said: "Topped off our donor-advised fund with the tax lots in our taxable portfolio that had the biggest long-term capital gain this year."

"Nothing extraordinary, just the usual donations of appreciated stock to our favorite nonprofit charities and the contribution to our Roth IRAs to take advantage of the potential tax free growth," said BMWLover.