Can some one please explain low basis stock concept in details. I feel stubid related to this concept.
could you be referring to low “cost” basis. in that case, just simply have bought a stock much lower then where it’s trading today… tax implications are high for selling, a really good problem to have…
OK - you will need to suspend disbelief for a second. It used to be (i.e., before the Bush Administration) that you could buy a stock and have some reasonable belief that it would INCREASE in value. That’s right, INCREASE, even after paying dividends. That means you could buy a stock at $2 and sometime later it might be worth $20. That would mean that you would have a capital GAIN in the stock that was nearly the entire value of the stock. I can understand why you feel stubid on this concept. I keep forgetting what that was like, too.
Many investors are reluctant to sell a stock(s) with very low cost basis due to the “voluntary” realization of capital gains taxes. Also, if they hold the stock until their death, the heirs will receive a step-up in basis; the heir’s basis will become whatever the stock price was at the original owner’s date of death. So in Joey’s example above if the stock owner died when the stock price was $20, the new owner (heir) basis would be $20 instead of $2. Under current tax law the $18 dollars of capital gains would never be taxed. For these reasons various strategies are used to try to avoid/delay taxes and immunize/decrease the risk associated with single positions (especially if they are a large portion of net worth).
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It also is the basis for “death arb”. If you play your cards right, you can make lots of money from dying. Our recent stock market debacle makes death arb more difficult, so a possible consequence of the meltdown is increased social security payments, pension benefits, etc as people find that the return from dying has been severely curtailed.
I recently came across a family portfolio that owned a bunch of low cost basis shares in a company that has been in the news lately. Obviously, it was a long-time holding. The people in charge of the portfolio held onto the shares as they cratered, and they lost about half of the overall portfolio value. My guess is that they didn’t diversify out of the position because they didn’t want to incur the 15% capital gains tax on the sale. And now they have a portfolio loss of about 50% to show for it. Even before this, it occured to me that people make really stupid financial decisions because they’re irrationally afraid of taxes.
There are things they could have done to decrease the taxes and still diversify. But I agree, letting the tax tail wag the dog doesn’t make much sense.
mwvt9 Wrote: ------------------------------------------------------- > There are things they could have done to decrease > the taxes and still diversify. Hazy memories… I’m so glad I don’t have to answer a morning session question on this right now. Could I pass Level 3 again if I took the test right now? Oh hell no!
JoeyDVivre and MWTV9 thanks alot 
i want to ask you guys if schweser is realy ( poor writing ) this year than the previous 2 levels or it is just me ?
very helpful thread!
mwvt9 Wrote: ------------------------------------------------------- > Many investors are reluctant to sell a stock(s) > with very low cost basis due to the “voluntary” > realization of capital gains taxes. Also, if they > hold the stock until their death, the heirs will > receive a step-up in basis; the heir’s basis will > become whatever the stock price was at the > original owner’s date of death. So in Joey’s > example above if the stock owner died when the > stock price was $20, the new owner (heir) basis > would be $20 instead of $2. Under current tax law > the $18 dollars of capital gains would never be > taxed. Hi, so they would avoid paying capital gain tax but wouldnt they have to pay for inheritance tax upon transfer of assets to heir? is the inheritance tax is lower than capital gain? thanks
Inheritance tax is way higher but only kicks in at 3.5 million or something.
JDV is right. They would avoid the capital gains tax but could potentially have to pay inheritance taxes. You can pass so much “stuff” to your heirs without being hit with the death tax. Currently the exemption is 2M per person and set to jump to 3.5M each in 2009. Once you get over that amount you better hold onto your hat because Uncle Sam gets a the lion’s share to the tune of 45% for Federal. Tack on State and you can be over 50%.
The reading mentioned a few strategies for dealing with low cost basis stock including transfering it at death as mentioned above, hedging the position with derivatives, and recognizing losses in order to offset to offset gains among other things.