Interviews by
Lisa Singh
The PIGS-and-PALS Approach
By John Enright
In my practice, many clients have investment real estate that may provide them positive cash flow (i.e., actual income less actual expenses). As is, the investment is generating passive losses that can’t be utilized until the investment generates passive gains. The expenses associated with the investment property, such as mortgage interest, upkeep, taxes, management fees and depreciation, are subtracted from the rental income received. If this difference is negative, the investment is a PAL or passive activity loss. The client needs to have PIGS, or passive income generators, to offset these losses. Unfortunately, though, these losses often continue to accumulate and are carried forward for years. Looking for ways to offset these passive losses opens up several planning options including the purchase of a direct participation program or a limited partnership. The PIGS-and-PALS approach helps the client maximize the benefits provided by the investment real estate.
Here’s how the process works: When I meet with a client for the first time, I look at various financial documents, particularly his tax return. The information on his Schedule E includes his investment real estate. If it shows losses, I ask, “How do you anticipate using these passive losses?” Most of the time, the client has no idea. That’s when we discuss the option of buying a direct participation program or a limited partnership to produce passive income. With this option, the client could earn a 6 percent or 7 percent dividend that would have been mostly taxable income if he didn’t have any passive losses. But depending on how those passive losses are paid from the direct participation program or a limited partnership, it may allow him to offset the taxable income so dividends become untaxed income until the client exhausts the passive losses that he has accumulated.
To better illustrate this idea, here’s an example: Assume that a client has $50,000 in passive losses that continue to grow and he can’t use those losses at this time. He puts $200,000 into a direct participation program or a limited partnership and earns 6 percent. The result is $12,000 of passive gains that are offset by his passive losses. For the next four years or so, he’ll have $12,000 of untaxed distributions because it’s being helped by his passive losses. Not all direct participation programs or limited partnerships are PIGS, so an advisor must be careful in his recommendation. But under the right circumstances, you can help your client “bring home the bacon.”
John Enright is an advisor with Sagemark Consulting and a member of Syracuse AIFA. Contact him at John.Enright@lfg.com.
Covered Call
By Brent Spicuzza, CFP
If you have a client with a portfolio that is either trading flat or not going up a whole lot, but he doesn’t want to sell the stock for fear of missing out on its projected long-term gain, here’s a technique—conservative, yet reliable—to generate more income in the portfolio in the meantime. Tell your client that he can probably increase the income on his portfolio by 5 percent to 10 percent a year by doing covered calls—a strategy where he sells the right for someone else to buy the stock in question at a certain time and price. In return, your client receives a solid premium for the temporary sale.
So, let’s say your client has 1,000 shares of Anheuser-Busch stock, which isn’t yielding much of a return in the short run. You can write a covered call on the stock, something short-term, say in August or September. Your client, in turn, may be able to collect another $300 to $400 of income. In my own practice, I’ve found that my clients generally like the covered call strategy because it’s a way for them to hold on to their stock in the long run, while generating a lot more income in the meantime without taking any risk.
For instance, with that 1,000 shares of Anheuser-Busch stock, let’s say the stock stands at $47—that’s $47,000 total. If you could generate $300 every 60 days, multiply that by six months or six times a year, that’s almost $2,000 on a $47,000 investment, which is 5 percent a year. In the end, if you don’t suggest a strategy like this to your client, someone else probably will—and your clients may go elsewhere because you’re not bringing the best investment ideas to the table.
Brent Spicuzza, CFP, is founder of The Planning Associates, LLC, in St. Louis, Mo., and a member of NAIFA-St. Louis. Contact him at brent.spicuzza@axa-advisors.com.
August 2006
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