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Given the probability of a market correction, is it a good strategy to convert the securities in a revocable trust valued at $518,000 to cash, considering the tax liability? 

I'm the trustee of my parent's revocable trust and I have three siblings. My father passed away in September 2017. My mother's health declined in January 2018 and passed away in February 2018. The trust was valued at $518,000 in January 2018. The stock market appears to be on the verge of a correction, so I determined that it was worth the risk to convert all the securities to cash. The $84,000 in capital gains represents a tax liability of around $16,000. My thinking was the market could easily move lower than that amount. Is this a good strategy?

Estate Planning, Stocks, Taxes
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March 2018

I'm sorry, I had originally read that your Mother very ill & I didn't catch that she had passed as well.  My condolences, but the step-up in basis below still applies, just the dates for the step-up will be modified.  The point still is that you will have little or no capital gains as your cost basis (step-up) will be reset to FMV as of the date of death.  All the other comments below regarding the markets still apply.


My first question is whether you marked up the cost basis to your Dad's date of death because you get a step-up in basis to the FMV of assets.  So is the $84k capital gains from the stepped-up cost basis from Sept 2017, or when you parents originally purchased the securities.  You may have a lot less tax than you think and might need some help with tax & estate planning issues.  This would also make the selling decision a lot easier and less painful.

Regarding the markets themselves, I learned a long time ago that what "I think" doesn't mean anything to the markets and unfortunately the markets don't care about me at all.  More importantly, I do not want to project my opinions onto said markets because I will be wrong more than I am right.  What matters is what the markets are actually doing.  Case in point, last year was way out of the norm and a huge outlier for lack of volatility.  The markets almost never act that "calm," so when normal volatility does arise or even return to just normal, it "feels" scary emotionally and like we are on the verge of collapse.  But statistics show us that most positive stock market years have one double digit correction per year and many have two.  But we just went through a 14+ month period of extreme calm so any increase in volatility feels impending. 

All that being said, I am not a perma bull and we are in a mature bull market. But the markets can go up a lot longer that you think, but will also sell off and go down quicker and faster than you think.  So I always want to have an exit strategy.  With this recent volatility, we actually raised cash and currently have approximately 20% cash & a short ETF hedge, and therefore have 75% "net equity" exposure. 

Normally you don't want to make "all in" or "all out" moves but rather make moves in waves, thus taking some risks off the table or adding risks on the table. If you move to 100% cash & then the markets go up for another 4 to 5 months, what will you do?  How long will you wait before throwing in the towel & then buying to high because you are impatient? The only reason I bring this up is because you need to have measurable metrics & facts to be able to determine probabilities, and then have multiple scenario plans for "what if the markets move higher" and "what if the markets move lower."  There are only a couple of indicators or signals that would make us move almost 100% defensive at once.

Now, if you have strong, quantifiable reasons to believe that the market will correct more than the net after paying the taxes, then by all means sell.  But there are also other ways to hedge or protect a position with big gains.  If most of those capital gains are due to one or two single positions, you may want to buy a put option on that position to protect against loss.

I know this was a lot to think about, but I wanted to give you a different perspective than the "conventional" answers I am sure you are getting.  First thing is to check on the cost basis.

Hope this helps and best of luck, Dan Stewart CFA®

March 2018
March 2018
March 2018
March 2018