Dateline: Kuala Lumpur, Malaysia I’ll never forget CNBC’s Jim Cramer during the mortgage boom shouting “I want you to buy Annaly Mortgage!” The loud-talking celebrity investor has had a lot of bad calls over the years, leading one website to test Jim Cramer’s investment picks versus those of a monkey to barely differentiated results. Few were as bad as the drubbing that his subprime mortgage boom picks he hawked in the “good years” of US real estate. Now, Jim Cramer has a new recommendation. He says that not following it is “the single biggest investment mistake ever”. What is it? Holding on to winning stocks in hopes of selling them later when capital gains taxes are lower. It’s a story as old as time; at the end of each year, traders sell off their losing picks as capital losses for a tax deduction, while investors with winning stocks try to keep the winning performance going until the one-year mark in order to sell at a lower capital gains tax rate. The fact that the United States and other countries tax short-term capital gains at higher income tax rates, while taxing long-term capital gains are lower rates is part of the reason we encourage investors to look beyond bankrupt western countries for their investments. With the types of socialist politicians gaining traction these days, it will only be a matter of time before long-term capital gains are taxed as ordinary income, too, but until then, investors will look for any edge they can get.
Should you wait to sell stocks for tax reasons?
As you might expect, I take a rather agnostic view of this situation. Sure, Jim Cramer is right in that you should not hang on to stocks you believe might not perform as well merely to save money on taxes. Especially in today’s bloated US equities market, the bottom could fall out – or at least weaken – at any time, and you don’t want to be caught holding the bag. As much as I hate paying taxes, I like making money for myself even more. For instance, when I advised my parents to buy Yahoo stock in the mid-1990s, they didn’t hold on from $25 all the way to $800. They cashed out at a pragmatic point with excellent gains and a healthy tax bill. In fact, I’ve always cringed at the non-business owners who claim that entrepreneurs waste money “for the tax write-off”, as if spending $1 foolishly to save $0.40 is a smart business decision. Yet it is those uneducated people who are the electorate deciding future tax policy. To me, however, the core issue at hand is not “should I sell my stocks early and pay a higher tax rate?” but rather “why am I not investing in a more tax-efficient way?” Before we discuss several ideas to consider, remember that I am not a tax advisor or other licensed professional. That said, for US citizens, tax-efficient offshore investing is quite difficult. My team has helped folks set up offshore trading accounts and the offshore companies that hold them. This strategy usually doesn’t involve a lot of tax advantages for US citizens or residents, however, because US citizens and residents must report and pay tax on all passive income anywhere in the world. Unless the IRS deems you a professional trader, your investment income is deemed passive, and the tax advantages of going offshore are minimal if any. It also doesn’t help that many offshore brokerages don’t want to even bother with US citizens, considering that foreign brokerage accounts are treated as financial accounts under FATCA and are reportable on your FBAR. While a Belgian citizen can easily walk into a bank in Singapore and open an offshore trading account with minimal capital and minimal fuss, Americans don’t have that privilege. FATCA makes it nearly impossible. That means that options for investing offshore are limited if you’re a US citizen or the resident of a high-tax country that taxes your investment income earned overseas. My advice is simple: consider alternatives. When the tax policy for one type of investment is out of favor, consider another angle. Here are several ideas…
Consider alternative asset classes
Foreign real estate is an excellent asset class with great tax benefits. It’s also one of the few non-reportable assets you can own. Real estate can be advantageous for tax reasons because it’s unlikely you would hold it for less than one year, and it’s far less likely than stocks to tank at a moment’s notice. Even if you’re a real estate flipper, it’s possible to stretch the process to almost twelve months in many countries. A friend of mine is flipping real estate in Cambodia for substantial returns, yet the turn-around estimate on a project is 6-9 months, and I suspect some will take even longer. Foreign real estate also offers the potential for a 1031 exchange to defer taxes. Similarly, with the US dollar being so strong now, it might be worthwhile to look at precious metals stored offshore. I suspect it will be more than one year before gold shows significant capital gains.
Move to Puerto Rico
I’m not a big fan of Puerto Rico’s tax incentives precisely because I don’t put a lot of faith in the US government to keep them going. One stroke of the pen in Washington – or bullying to induce the stroke of a pen in San Juan – could bring all of Puerto Rico’s tax incentives for investors to an end. However, if you are a short-term trader, Puerto Rico offers zero capital gains tax as well as a very low ordinary income tax rate. Moving to Puerto Rico as an investor seeking lower taxes can be expensive if you engage a “done-for-you” service; I’ve seen prices ranging as high as the low six-figures.
Move to a low-tax country or renounce your citizenship
If you’re a US citizen, the only option you have to avoid US tax altogether is to renounce your citizenship. If you’re a serious trader making substantial income, it might be worth considering even if you have to purchase an economic citizenship. Depending on which markets you trade, it would be possible to reduce taxes on your investments from federal ordinary income tax rates as high as 39.6% to potentially 0%; the $140,000 or so it would cost for a second citizenship might be a drop in the bucket, although it is a big and emotional decision to make. If you’re not a US citizen, your route to lower taxes is easier: you simply have to move. Belgium, for instance, is one of a number of countries with no capital gains taxes. There are plenty of highly-livable low-tax countries for investors where profits on your traders will be yours to keep. In fact, getting residency in Belgium is relatively easy, and it can lead to citizenship. Reducing taxes on your investments is an important part of preserving your capital. I love repeating the childhood example of how a penny doubled every day for a month equals $10.7 million… UNLESS you take out taxes on every day’s profits, in which case the number is far punier. When it comes to making investments, consider looking at alternative avenues rather than accepting that you MUST invest in stocks, or bonds, or real estate. If you feel trapped in your investments due to bad tax policy, consider a different game entirely.