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Forego ACA Subsidy Until Next Year?
Old 11-19-2017, 11:34 AM   #1
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Forego ACA Subsidy Until Next Year?

I'm asking for a second look on my ACA subsidy strategy, to make sure I'm not missing anything.

For some background, I'm single, just turned 56, and have about 3/4 of my investment assets in a taxable account: 3% CDs maturing Dec 2018, and 3 Vanguard funds: Total Stock, Total International, and PRIMECAP. Roughly 7/32/41/20 split of those investments, which is not my total AA. I also have some in a tIRA that I am trying to convert to Roth over time, ideally before I start SS and a small pension.

In 2016 I found that I was able to manage income to take a smallish subsidy, so I did, getting the credit back when I filed taxes (not an important detail). Interest, divs and CGs took up most of the 400% FPL space, and I was able to make a small conversion. CGs were actually canceled by some cap loss harvesting, and I have a pretty good carryover to 2017. I figured I could milk this carryover for a few more years and get the subsidy for the foreseeable future, not being sure how long it will exist.

For 2017, the subsidy is a bit larger, $2076 for the year, so I applied to get it as a monthly reduction. Now I find out that one of my mutual funds (VG PRIMECAP) is throwing large CG distributions at the end of this year. I can still barely qualify for the subsidy for 2017, but I'll use up all of my capital loss carryover. This means I'm practically guaranteed to lose the subsidy in subsequent years if I make no changes, unless Primecap gives much smaller subsidies in those years. The uncertainty of this tax inefficient fund makes planning difficult.

In 2018 my subsidy at 400% FPL would be much larger, $8736, if I can get there.

Also, I tried the horserace conversion strategy this year, converted 2x a lot more than I know I can convert to stay under 400%, and one of them is up over 20%. The safer one is up about 2-3%. Combined they've appreciated about $5000. I had planned to recharacterize all of the loser, and much of the winner to get under 400% FPL. I'd be putting back about $4000 in gains, which is probably worth about $400-600 in tax savings if I could keep it in the Roth.

So, my thought is to give up the 2017 subsidy, and sell off Primecap in 2017. It would be a 6 figure LTCG, virtually all taxed at 15% It's been a great investment for me but maybe it wouldn't be the worst idea to take my profits since there's no guarantee it will continue to beat the market. I have a small amount in my Roth that I'd keep so I could buy more each year--it's a closed fund and existing holders can buy $25K more each year.

Since I'd be way over 400% FPL in 2017, I might as well keep all of the Roth conversion horserace winner, and maybe even convert to the top of the 25% since this might be the only year to convert a lot. From my calculations, if I moved it to index funds I'd qualify for the subsidy in 2018 by a thousand or so. So it'd be close, and there's a possibility of larger dividends or possibly even a CG distribution from one of those indices (has that happened before?).

I have had an HSA policy and will continue it in 2018, taking the max $4450 deduction next year including the over 55 catch up. If I find I'm just over to 400% FPL in 2018, I could cash in one or more of the CDs to deduct the early interest penalty. Canceling out $1500 interest is worth not losing $8000+ in subsidy if it comes to that.

I'm not seeing any other tricks to reduce MAGI unless I started a business and lost money on it. Not sure I really want to go to that effort. I don't have any kind of business in the works. I don't have any unrealized capital losses and as I said, the carryover will get used up in 2017. The only other reduction I see that could apply is if I paid some alimony to my ex-, but I don't want to go anywhere near that route.

There is one wildcard, I have a townhouse that my son lives in rent free. I own it outright. I don't see how I can turn that into a money loser if I took out a loan and charged him market or near-market rent, could I? There's also the complication that he may move out of the area, in which case I'd sell it and might be taking a small gain. I have the receipts from improvements I made when I bought it, plus there will be closing costs, but it's going to be close.

So the ultimate question is, should I take the ~$1500 bird in the hand this year (subsidy less returned Roth profit tax break), or give it up and go for $8000+ subsidy next year and give myself a chance at subsidies in future years, given there is a small chance I would miss the subsidy? I also don't want to predict how long the subsidies will last.

And is there a more tax efficient investment wrt to MAGI to make instead of adding to the index funds I have? The bond funds I have in my IRAs throw more income than the indices throw dividends. Tax free munis are added to MAGI so those don't help. I don't think I want to sabotage my investments and get poor returns since the lost opportunities would probably be more than the $8000 subsidy.

Maybe I'm making too big of a deal for $8000, but it could be more each year until I hit medicare age if subsidies continue.

Thanks to anyone who waded through all of this to comment. I just ask that you don't do a quick scan and make some suggestion like "get an HSA plan," which I'm already doing.
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Old 11-19-2017, 12:24 PM   #2
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The first principal should be - don't do anything to compromise your long term portfolio returns (AA) for short term tax or subsidy reasons.

Also keep in mind, that index funds do distribute dividends and the amount depends on the asset class.

I'm in a similar situation - active funds that I've owned for a long time with a lot of cap gains that are very irregular in their distributions.

Our taxable distributions have been greater than 400% of FPL the past few years, but the ACA cliff hasn't been that high for me. Next year, the cliff is greater than $900/mo, so I'm trying to position my portfolio to generate more predictable distributions & hopefully stay below 400% FPL. That means more index funds.

To that end, I plan to exchange one of my active funds with a comparable index fund. I don't feel comfortable jettisoning all active funds and paying the substantial tax that would entail. After all, we do use those distributions for our cash needs during the year. I have enough in an ST bond fund, that will, along with fund distributions, meet our expenses for the next two or maybe three years.

We use HSA policies too.

In exchanging funds this year, we'll have funds acquired at today's high prices. That may mean that there will be unrealized losses that can be used to offset some distributions or income. Not that I want that to happen, but if it does, it could lead t some good.

Other than that, I don't think there's much that can be done. In the larger scheme of things, it is a "good" problem to have.
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Old 11-19-2017, 12:46 PM   #3
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Thanks for your responses.
Quote:
Originally Posted by walkinwood View Post
The first principal should be - don't do anything to compromise your long term portfolio returns (AA) for short term tax or subsidy reasons.
I agree with that. Or at least, don't do much. As I pointed out, if I'm barely over the cliff, paying a small early withdrawal penalty on the CDs would be worth pulling myself back under 400% FPL.

I guess my way of looking at it, if I had the cash on hand today, would I buy a lot of Primecap, or the Index? Primecap has been great, but there's no way to predict if that will continue. I would trade it for something reasonably equivalent. I would also feel bad if Primecap trailed the index next year, but still had the cap gains to put me over 400% FPL.

Quote:
Also keep in mind, that index funds do distribute dividends and the amount depends on the asset class.
Right, I've factored in the predicted dividends if I swapped Primecap for my index funds.

Quote:
In exchanging funds this year, we'll have funds acquired at today's high prices. That may mean that there will be unrealized losses that can be used to offset some distributions or income. Not that I want that to happen, but if it does, it could lead t some good.
A good point. If there is a correction, losses would be available to use.
Quote:
Other than that, I don't think there's much that can be done. In the larger scheme of things, it is a "good" problem to have.
It really is a good problem. If I were way above 400% FPL I wouldn't worry about it, but being on the edge makes it hard to not do everything I can to get ~10% of my budget subsidized.
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Old 11-19-2017, 02:49 PM   #4
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In their fund analyses, Morningstar usually includes a data point on undistributed gains. It might be worth your while to estimate how much of Primecapís gain will remain unrealized after this distribution. If itís a much smaller % of assets, the risk of anothe large distribution next year is much lower. OTOH, if even after this distribution there is still a sizable amount of unrealized gain, switching to an index fund makes more sense because of the greater expected health care assistance.

We (or other family members) have held other active Vanguard funds that have made large distributions in the past, such as Health Care and Intíl Explorer. Large distributions are normal, but not two years in a row.
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Old 11-19-2017, 03:24 PM   #5
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I own Primecap in my taxable account also. According to my records, the long term capital gains over the last 5 years are (or will be) as follows
2013 5.0%
2014 5.9%
2015 5.1%
2016 4.0%
2017 4.4% (estimated)
So, I agree the capital gains are not small, but they certainly have been larger. Also, according to Vanguard, the fund has 54.77% in unrealized appreciation. The potential for larger declared capital gains in the future is high. Therefore, if I were in the OP's position, I would sell the fund and purchase the index. Although I hate to recommend that because it probably means I will get hit with more declared capital gains next year because of that sale. haha. Seriously, I will not be selling mine because my total CG and Divs make up less than 160% of FPL and even if the Primecap CGs doubled, my ACA MAGI and subsidy will not be in danger.
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Old 11-19-2017, 05:01 PM   #6
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Great information/suggestions from both MichaelB and NO2L84ER, thank you! For some reason I thought the Primecap distributions were a lot less in 2016 but I was using today's balance, not last year's. I confirm the 54.77% unrealized CGs so it does seem likely to keep giving them next year.


Wait! Why did I think LTCGs were so much higher this year? I must've used a wrong number, because now I'm seeing I'll use up a little less than half my carryover. So I probably will be ok in 2018 even if I do nothing.


But what about 2019? If the subsidy will still be around then, it'll probably be worth a lot more than it is in 2017, and I'll probably use up most or all of the carryover in 2018.


Bottom line, I'm an idiot for doing the numbers wrong, and embarrassed myself for exposing it publicly, but I'm glad I started the thread anyway. NO2's post shows that this year was pretty ordinary and made me take another look. And I still have the same decision to make, but it's for 2017 vs. a more uncertain 2019, not 2018.
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Old 11-19-2017, 05:21 PM   #7
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If I understand this correctly..

You are right on the edge of the "subsidy cliff". You don't have many options to manage your MAGI income under the subsidy cliff. To make matters worse, you own a fund that throws off unexpected capital gains income, which makes management of your MAGI income even more difficult.

You can sell this unpredictable fund this year, which means you would incur capital gains that would result in the loss of a modest subsidy this year. However, that would put you in a position where you could more easily plan and manage for MAGI to receive much higher subsidies in the future.

However, you don't know if the subsidies will last much longer. There is a lot of political uncertainty around these subsidies.

Another question you need to answer is ..at what point will growth of your dividends and interest, absent of the capital gains from that one unpredictable fund, outpace the 400% FPL level that triggers the subsidy cliff?

The FPL tends to increase 1-2% per year. But dividends tend to increase more than 5% per year. Using these assumptions, I created a spreadsheet which showed that my dividend income will exceed the subsidy cliff beginning next year, even after accounting for an HSA deduction.

With this in mind, I decided not to take capital gains or Roth conversions this year or next year. Instead, I will draw down my cash reserves in order to lock in my remaining two years of subsidies. Beginning in 2019 I will no longer be able to play the subsidy game as I'll be over the cliff, so I might as well take advantage of it while I can.

If I were you I would sell that unpredictable stock fund this year, forego this year's modest $1k subsidy, build up some cash reserves, and then try hard to maximize the $8k subsidy next year and hope that there is more available after that. I think it is a good bet that the subsidies will remain for a least a couple of years more. And if not, well you did what you could, and losing a $1,000 subsidy is not a big deal in the grand scheme of things. As for the extra capital gains taxes you will have to pay this year, well, you would have to pay that eventually anyway if you sold the fund in the future. At least this year you have a good reason.

But first, project your income and the subsidy cliff for the next few years. If you see where you could manage to remain under the subsidy cliff for more than a couple of more years, than all the more reason to adjust your portfolio accordingly for more predictable income. I suspect, like me, eventually your interest and divided income will outpace the FPL growth and you will automatically be pushed over the cliff no matter what you do so you might as well try to maximize the subsidies while you can.
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Old 11-19-2017, 05:30 PM   #8
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Originally Posted by walkinwood View Post
... index funds do distribute dividends and the amount depends on the asset class...
I would like to expand on this a bit more.

Even if a mutual fund manager follows an index and does not churn his stocks, he still realizes capital gains when some of his shareholders want to cash out and redeem the MF shares. He will have to sell some stocks in order to have cash to return to these shareholders. The cap gains realized from the sales are divided among all shares and reported as distributed, even to shareholders who do not sell anything.

On the other hand, when you own an ETF share, it is like an individual stock share. Other people who bail out of the market are selling their own shares, which have nothing to do with the shares that you own. You would not be faced with cap gain distributions that you would with a mutual fund share.

The above is not directly related to the OP's question, but I just like to point out one advantage of the ETFs over the MFs. While they may have the same stock components, the accounting method and tax treatment are different.
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Old 11-19-2017, 05:41 PM   #9
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Quote:
Originally Posted by truenorth418 View Post

...

If I were you I would sell that unpredictable stock fund this year, forego this year's modest $1k subsidy, build up some cash reserves, and then try hard to maximize the $8k subsidy next year and hope that there is more available after that. I think it is a good bet that the subsidies will remain for a least a couple of years more. And if not, well you did what you could, and losing a $1,000 subsidy is not a big deal in the grand scheme of things. As for the extra capital gains taxes you will have to pay this year, well, you would have to pay that eventually anyway if you sold the fund in the future. At least this year you have a good reason.

But first, project your income and the subsidy cliff for the next few years. If you see where you could manage to remain under the subsidy cliff for more than a couple of more years, than all the more reason to adjust your portfolio accordingly for more predictable income. I suspect, like me, eventually your interest and divided income will outpace the FPL growth and you will automatically be pushed over the cliff no matter what you do so you might as well try to maximize the subsidies while you can.
Good advice. I'll try to project a few more years and see how it looks. Thank you.
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Old 11-19-2017, 05:47 PM   #10
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I would like to expand on this a bit more.

Even if a mutual fund manager follows an index and does not churn his stocks, he still realizes capital gains when some of his shareholders want to cash out and redeem the MF shares. He will have to sell some stocks in order to have cash to return to these shareholders. The cap gains realized from the sales are divided among all shares and reported as distributed, even to shareholders who do not sell anything.

On the other hand, when you own an ETF share, it is like an individual stock share. Other people who bail out of the market are selling their own shares, which have nothing to do with the shares that you own. You would not be faced with cap gain distributions that you would with a mutual fund share.

The above is not directly related to the OP's question, but I just like to point out one advantage of the ETFs over the MFs. While they may have the same stock components, the accounting method and tax treatment are different.
Good points. In my case, I don't think either of the index funds I'm looking at have had CG distributions, probably because they take in more in purchases than they pay out in redemptions. Not a guarantee for the future but the trend is there. Also VG ETFs are a special case, I believe, and are treated just like the corresponding index fund for tax purposes.

In general, it's a great thing to keep in mind in deciding on ETFs vs. mutual funds and your advice could certainly help someone investing outside of VG.
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Old 11-19-2017, 08:28 PM   #11
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One thing to consider.... a number of years ago I concluded that foregoing ACA subsidies in favor of low tax cost Roth conversions between ER and SS was better for us. Since I made that decision, I have converted ~ $275k and paid ~8% in tax. Assuming these would have ultimately been taxed at 25% if I had held back to tax subsidies I have saved ~47k... ~$9k a year and much more than the value of subsidies. The other factor was the the value of subsidies to us was not alot due to some fairly unique circumstances.
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Old 11-19-2017, 08:36 PM   #12
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Originally Posted by NW-Bound View Post
I would like to expand on this a bit more.
On the other hand, when you own an ETF share, it is like an individual stock share. Other people who bail out of the market are selling their own shares, which have nothing to do with the shares that you own. You would not be faced with cap gain distributions that you would with a mutual fund share.

The above is not directly related to the OP's question, but I just like to point out one advantage of the ETFs over the MFs. While they may have the same stock components, the accounting method and tax treatment are different.
+1
I use equity ETFs in taxable account. Years ago I got caught with MF distributing 20% to 25% and moved away from them in taxable accounts.
It is not good to let taxes or subsidies screw up you investing decisions.
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Old 11-19-2017, 09:41 PM   #13
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I am keeping my MAGI as low as I can to keep getting current subsidy as long as I can... I would not sacrifice a year unless there was no way not to... Once sacrificed, I would only sell to the top of the 15%... I would not go any higher...

Rinse and repeat...


BTW, I believe something else will come along in a few years... anyway, I have 5 years until Medicare but still will be insuring DW and DD.... not sure how subsidy will go then....
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Old 11-19-2017, 10:36 PM   #14
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Originally Posted by RunningBum View Post
Good points. In my case, I don't think either of the index funds I'm looking at have had CG distributions, probably because they take in more in purchases than they pay out in redemptions. Not a guarantee for the future but the trend is there. Also VG ETFs are a special case, I believe, and are treated just like the corresponding index fund for tax purposes.

In general, it's a great thing to keep in mind in deciding on ETFs vs. mutual funds and your advice could certainly help someone investing outside of VG.
It is good that you point out that VG ETFs are not like ETFs offered by other institutions, and do not have the tax advantage I mentioned.

Here's what Vanguard site says: "Vanguard ETFs are a share class of Vanguard index funds, so they'll declare dividends whenever the other share classes do".

I do have some Vanguard ETFs but they are inside IRAs, hence I have not paid much attention to the above matter.
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Old 11-20-2017, 08:46 AM   #15
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Originally Posted by pb4uski View Post
One thing to consider.... a number of years ago I concluded that foregoing ACA subsidies in favor of low tax cost Roth conversions between ER and SS was better for us. Since I made that decision, I have converted ~ $275k and paid ~8% in tax. Assuming these would have ultimately been taxed at 25% if I had held back to tax subsidies I have saved ~47k... ~$9k a year and much more than the value of subsidies. The other factor was the the value of subsidies to us was not alot due to some fairly unique circumstances.
I'm still trying to get a handle on the value of Roth conversions, especially when you can see the value of the subsidy today with cash in hand. But clearly this is a trade-off.

The issue I have is that I don't have that much room within the 15% bracket to convert. But it may be that for my smaller subsidy this year, skipping it in favor of conversions is probably best anyway, especially if it allows me to take much larger subsidies.

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Originally Posted by Texas Proud
I am keeping my MAGI as low as I can to keep getting current subsidy as long as I can... I would not sacrifice a year unless there was no way not to... Once sacrificed, I would only sell to the top of the 15%... I would not go any higher...
As pb4 says above, Roth conversion has value too, maybe more than a small subsidy. And the reason I'm considering going over 15% is that in retirement, I think I'll be at that point where RMDs get taxed at 15% and also push more dividends into being taxed at 15%, so a 25% conversion now is better than paying 15+15% later, if those rates still apply. I know I'll have a small window this year where I'd be converting at 15+15% but it may be worth it this year to go past that window and do the full 25%, especially since I have that 20+% gain on part of the over-conversion that I did.
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Old 11-20-2017, 08:47 AM   #16
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I very much appreciate all of the thoughtful and on-target responses to my post.
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Old 11-20-2017, 09:27 AM   #17
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I'm still trying to get a handle on the value of Roth conversions, especially when you can see the value of the subsidy today with cash in hand. But clearly this is a trade-off.

The issue I have is that I don't have that much room within the 15% bracket to convert. But it may be that for my smaller subsidy this year, skipping it in favor of conversions is probably best anyway, especially if it allows me to take much larger subsidies.


As pb4 says above, Roth conversion has value too, maybe more than a small subsidy. And the reason I'm considering going over 15% is that in retirement, I think I'll be at that point where RMDs get taxed at 15% and also push more dividends into being taxed at 15%, so a 25% conversion now is better than paying 15+15% later, if those rates still apply. I know I'll have a small window this year where I'd be converting at 15+15% but it may be worth it this year to go past that window and do the full 25%, especially since I have that 20+% gain on part of the over-conversion that I did.

True.... if the future shows you will be paying a lot more in taxes than today it might be something to think about...

But have you looked at where the rates will be with either of the proposed tax cuts (mods... not trying to debate them)... might be worth a look and see how things might change if passed...

I also agree that a small subsidy might not be worth the trouble... however, mine is huge... still have 2 kids along with DW and me on a plan and that means I need to wait until the subsidy goes down....
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Old 11-20-2017, 09:59 AM   #18
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True.... if the future shows you will be paying a lot more in taxes than today it might be something to think about...

But have you looked at where the rates will be with either of the proposed tax cuts (mods... not trying to debate them)... might be worth a look and see how things might change if passed...

I also agree that a small subsidy might not be worth the trouble... however, mine is huge... still have 2 kids along with DW and me on a plan and that means I need to wait until the subsidy goes down....
I think we can tread carefully here, and not spend too much time. Yes, I've considered the current proposal, and also that there could be other changes in time. My understanding is that the proposed individual tax cuts are temporary and would expire before I get to Medicare age. Of course sometimes those kind of changes become permanent, but who knows? The ideal would be to do more conversions during the time when the tax rate is lower, but that's likely to be while I can take most advantage of the subsidy. In any case, I think that with my small pension, SS benefits, interest, dividends and CGs I'm always going to fill up the lowest bracket whether it's 15%, 12%, or whatever, so I'm not too concerned with relatively minor changes, and can't predict major changes.
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Old 11-20-2017, 12:05 PM   #19
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I would like to expand on this a bit more.

Even if a mutual fund manager follows an index and does not churn his stocks, he still realizes capital gains when some of his shareholders want to cash out and redeem the MF shares. He will have to sell some stocks in order to have cash to return to these shareholders. The cap gains realized from the sales are divided among all shares and reported as distributed, even to shareholders who do not sell anything.

On the other hand, when you own an ETF share, it is like an individual stock share. Other people who bail out of the market are selling their own shares, which have nothing to do with the shares that you own. You would not be faced with cap gain distributions that you would with a mutual fund share.

The above is not directly related to the OP's question, but I just like to point out one advantage of the ETFs over the MFs. While they may have the same stock components, the accounting method and tax treatment are different.


+1
Exactly why I own ETF's instead of MF's. At least it gives me some control over taxes.
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Old 11-20-2017, 12:53 PM   #20
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It hasn't been discussed much, but if you turned your townhouse into a rental, you might be able to depreciate it and create negative MAGI (Schedule C line 13 -> 1040 line 12). You can probably charge your son whatever rent you want, making any difference between what he pays and market rent a gift from you back to him.

Roughly speaking, you can depreciate the townhome's value divided by 27.5 each year, which should be several thousand dollars at least. This is in addition to any other expenses of maintaining the town home. It does generate the need to keep track of stuff from year to year, but it sounds like you're the kind of person who could handle that if you wanted to.

The depreciation needs to be recaptured at some future point when you sell the property (Section 1250 recapture @ 25%). You could perhaps manage that so that this sale and recapture happens in a future high tax year or in a year in which you are no longer eligible for subsidies.
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