Financial Advisors and the Contradictory Fiduciary Duties
Financial advisors face a unique challenge when it comes to managing client portfolios. They are tasked with two contradictory fiduciary duties: diversifying and rebalancing portfolios while also minimizing taxes. This creates a delicate balance that requires strategic planning and innovative solutions.
For high net worth clients, the ultimate tax-saving strategy is to pass away, allowing heirs to benefit from a step-up in basis and avoid capital gains taxes. However, since most clients prefer to stay alive, advisors must find alternative ways to diversify concentrated positions without triggering substantial tax liabilities.
One increasingly popular strategy that addresses this issue is a Section 351 ETF conversion. Under Section 351 of the tax code, investors can contribute appreciated stocks to a newly created ETF in exchange for ETF shares of equivalent value without incurring immediate capital gains taxes. This allows for diversification and risk management while deferring tax payments.
Re-indexing after Direct Indexing
Direct indexing involves purchasing individual stocks instead of a fund for tax-loss harvesting purposes. Over time, the lack of losers to sell can result in a portfolio that no longer mirrors the intended index. By utilizing a Section 351 exchange, investors can reset their portfolio by contributing winning stocks to an ETF, which handles the rebalancing back into the index.
Solving the Patient/Lucky Investor Dilemma
Individuals who have accumulated significant wealth in a single stock, whether through years of employment or lucky stock picks, face the dilemma of triggering substantial capital gains taxes upon selling. By exchanging these shares for ETF shares through a Section 351 conversion, investors can avoid immediate tax liabilities and continue compounding their wealth.
Dodging a Pending Forced Taxable Event
When faced with a pending taxable event, such as a company going private or an ETF liquidation, investors can swap their shares into a new ETF to defer taxes. This strategy is particularly useful in situations where a forced liquidation would result in unwanted tax consequences.
Cleaning House
Advisors often inherit complex portfolios with overlapping funds and multiple custodians. By consolidating these assets into a diversified ETF through a Section 351 exchange, advisors can simplify management and potentially reduce fees. This strategy aligns with an advisor’s value proposition of saving clients money on taxes and streamlining their financial affairs.
Overall, Section 351 ETF conversions offer a tax-efficient way for advisors to help clients achieve diversification, manage risk, and delay capital gains taxes. By leveraging this strategy, advisors can demonstrate their expertise in tax management and provide tangible benefits to their clients.
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