CTC Portfolio Management & Strategy 2 — Questions and Answers
Question 1: A client holds a concentrated position in a single stock with a very low cost basis. Which tax-efficient strategy allows diversification without immediately triggering capital gains?
- Sell all shares and reinvest in an index fund
- Use an exchange fund to swap shares for diversified interests (Correct answer)
- Donate shares to a DAF and replace with cash investments
- Elect Section 475 mark-to-market treatment
Correct answer: Use an exchange fund to swap shares for diversified interests
An exchange fund (partnership swap) lets the investor contribute appreciated shares and receive a diversified interest, deferring the gain until the fund interest is sold.
Question 2: Under the wash-sale rule, a loss is disallowed if the taxpayer purchases substantially identical securities within how many days before or after the sale?
- 15 days
- 30 days (Correct answer)
- 45 days
- 60 days
Correct answer: 30 days
IRC §1091 disallows the loss if substantially identical securities are purchased within 30 days before or after the sale, creating a 61-day window.
Question 3: A high-net-worth client wants to transfer a concentrated stock position to heirs at minimal transfer tax cost. Which strategy uses options to freeze current value for gift tax purposes?
- GRAT funded with appreciated stock (Correct answer)
- Installment sale to an IDGT
- Charitable remainder unitrust
- Section 1031 like-kind exchange
Correct answer: GRAT funded with appreciated stock
A GRAT (Grantor Retained Annuity Trust) funded with low-basis stock allows future appreciation above the §7520 hurdle rate to pass estate-tax-free to heirs.
Question 4: Which portfolio rebalancing method is generally most tax-efficient for taxable accounts?
- Calendar rebalancing — sell overweight assets quarterly
- Cash-flow rebalancing — direct new contributions to underweight assets (Correct answer)
- Threshold rebalancing — sell whenever any asset drifts 5%
- Tax-lot rebalancing — sell highest-gain lots first
Correct answer: Cash-flow rebalancing — direct new contributions to underweight assets
Cash-flow rebalancing uses new contributions or dividends to buy underweight positions, avoiding sales and therefore avoiding realized capital gains.
Question 5: A CTC is advising a client on asset location. Which type of asset is typically BEST placed in a tax-deferred account such as a traditional IRA?
- Broad domestic equity index funds
- Tax-exempt municipal bonds
- High-yield taxable bonds (Correct answer)
- Qualified dividend-paying stocks
Correct answer: High-yield taxable bonds
High-yield bonds generate ordinary interest income that is fully taxable, so sheltering them in a tax-deferred account prevents annual taxable income.
Question 6: A taxpayer sells covered call options against appreciated stock. If the call is exercised, how is the premium treated for tax purposes?
- Reported as ordinary income in the year received
- Added to the proceeds of the stock sale in the year of exercise (Correct answer)
- Deducted as an investment expense
- Excluded from income as a return of capital
Correct answer: Added to the proceeds of the stock sale in the year of exercise
When a covered call is exercised, the premium received is added to the sale proceeds of the underlying stock, affecting the gain or loss on the stock sale.
Question 7: Which of the following correctly describes a tax-managed fund's primary strategy to enhance after-tax returns?
- Maximizing portfolio turnover to capture short-term gains
- Systematically harvesting losses to offset gains while avoiding wash sales (Correct answer)
- Concentrating holdings in tax-exempt securities only
- Deferring all dividends until fund liquidation
Correct answer: Systematically harvesting losses to offset gains while avoiding wash sales
Tax-managed funds systematically harvest capital losses throughout the year to offset gains, while carefully avoiding wash-sale rule violations.
CTC Portfolio Management & Strategy 2
A client holds a concentrated position in a single stock with a very low cost basis.
Which tax-efficient strategy allows diversification without immediately triggering capital gains?