Strategic Selling of Equities: A Tax-Efficient Order of Operations

For investors and high-income earners, the sequence in which you sell your equity holdings can have significant tax implications. This guide provides a straightforward approach to determining the most tax-efficient order for selling various types of equities, from stock options to long-term investments. By prioritizing sales in a strategic manner, you can minimize tax liabilities and maximize financial returns.

For the purpose of this article, we are operating under two assumptions: first, the equity you are holding will continue to rise in price, allowing us to prioritize the sale of the least-tax-advantaged equity first leaving the most-tax-advantaged equity to hold on to maximize long-term capital gains (LTCG); second, that you have each type of equity listed below. We understand this is not universally true, but the concept remains the same. For someone with NSOs, they are always taxed as ordinary income, in contrast to someone who also has ISOs, which can ultimately achieve LTCG.

Step 1: Sell Unexercised NSOs First
Why Start Here?

• Immediate Taxation: Non-Qualified Stock Options (NSOs) are taxed as ordinary income upon exercise, based on the difference between the market price and the exercise price. Selling these first helps manage taxes efficiently, especially if the stock price is likely to rise, increasing potential taxes in the future.

• Simplicity: NSOs do not involve complications like the Alternative Minimum Tax (AMT), making them simpler to handle compared to ISOs.

Step 2: Move on to Unexercised ISOs
Optimizing ISOs:

• Potential for Lower Taxes: If you have the financial ability to pay any potential AMT and can hold the shares, exercise ISOs next. This setup allows for capital gains treatment on the increase in value after the exercise if held for the necessary periods (over one year post-exercise and more than two years post-grant). This can lead to substantial tax savings if the stock appreciates.

• Special Tax Treatment: There are advantages to exercising and holding shares for long-term capital gains treatment, but for the purposes of this article, if we need to sell equity, the next batch to consider after selling any unexercised NSOs, would be to exercise and sell ISOs. Effectively, this would be treated like NSOs, where they would be taxed as ordinary income, and because they’re sold at the same time, there are also no AMT implications.

Step 3: Sell Highest Cost Basis LTCG
Strategic Selling:

• Minimizing Taxable Gains: Once you've managed stock options, focus on selling shares that have the highest cost basis among your long-term holdings. This strategy minimizes the taxable gain—difference between the selling price and cost basis—thereby reducing your tax liability while still securing profits.

Step 4: Evaluate Lowest Cost Basis LTCG
Deciding on Low Basis Stocks:

• Consider Further Appreciation or Need for Liquidity: You might hold onto stocks with the lowest cost basis if you anticipate further appreciation, maximizing potential profits. Alternatively, sell these if you require liquidity or suspect a downturn, accepting the higher tax hit for the sake of realizing gains at the current high value.

Talk to an Advisor About Equity Sale Strategy

Managing your equity sales strategically can lead to significant tax benefits and enhanced portfolio returns. If you’re looking for expert guidance on how to implement these strategies effectively, our team is ready to help. Contact us today to schedule a consultation.

Step 5: Delay Selling STCG Where Possible
Last Step: Managing Short-term Holdings:

• Aiming for Lower Taxes: Aim to hold stocks that would generate short-term capital gains for over a year to qualify for long-term capital gains tax rates, which are significantly lower than short-term rates. This patience can lead to considerable tax savings, especially for stocks held for less than a year.

Maximize Your Returns Through Strategic Sales

Understanding and implementing a strategic order of operations for selling your equities can greatly enhance your financial outcomes. By following these steps, you align your investment activities with the most favorable tax implications, ensuring that you keep more of your hard-earned money.

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Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed.  

DiversiFi Capital LLC is a registered investment adviser located in CA and may only transact business or render personalized investment advice in those states and international jurisdictions where we are registered, notice filed, or where we qualify for an exemption or exclusion from registration requirements. Any communications with prospective clients residing in jurisdictions where DiversiFi Capital LLC is not registered or licensed shall be limited so as not to trigger registration or licensing requirements.

Past performance is not indicative of future returns, and investing always carries inherent risks, including the potential loss of principal capital. Any investment strategies are specific to individual clients and may not be representative of the experiences of all clients.