Is All Money Equal? – Tax Consequences on Your Investment Accounts

When it comes time to share your assets you need to be mindful of the valuation of investment accounts. If you have two accounts, both with a value of approximately $100,000 you might think that I will keep mine and my spouse will keep theirs. Sounds simple, but you need to look a bit deeper.

If one of the accounts is an active trading account and the other is used for long term investing, which is often the case with a balanced portfolio, the long term investment account may have long term capital gains inherent in the investments in the account where the other may have short term capital gains (I am being optimistic here rather than talking about losses, but the analysis is the same). This will result in a much different after tax number which you need to consider in the valuation.

Short term capital gains, when you have investment held less than one year, are taxed at your ordinary tax rate which is from 10% to 39.9% (federal tax rate) depending upon your income. Long term capital gains, investment held more than one year, are taxed at only 15% until you reach an income of over $415,050 where it jumps to 20%. That could be a big difference (19.9% of the value in the portfolio) in the tax cost associated with each portfolio.

When you consider who will keep which account, look at the income levels of each party. Will one spouse’s income be taxed at the 39% level where the other will be at the 20% level? To optimize the outcome for both of you perhaps the lower income level spouse gets the portfolio with the short term gains as their tax rate will only be 20% rather than the higher earning spouse who might pay 39.9% tax on the positions. In valuing the accounts the after tax number needs to be used.

You also need to look at your previous year’s tax return to see if you have capital loss carry forwards which might offset the capital gains associated with either portfolio; this could be used by the spouse to offset the capital gains. This loss carry forward is also a marital asset, which needs to be shared, but this is a topic for another day and is not an everyday occurrence.

The other alternative is that the spouse getting the portfolio with the short term capital gains can elect to hold everything until the portfolio shifts into the long term capital gain tax rate, which could be up to a year. This hold period can be detrimental in a trading portfolio which is geared to moving with the market so talk to your investment adviser! This strategy can also pose a liquidity problem if you wanted to liquidate the account to buy a house, pay for college or for living expenses.

Not an easy analysis so consult a Divorce Consultant to figure out the optimal solution that will net you the best result. Working tax issues into your property settlement agreement can be complicated and, in my experience, attorneys are not always aware of the possibilities to optimize your results so make sure you obtain the right financial advice before you make any decisions.

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