Locking in gains for home downpayment

[pb4uski]

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Originally Posted by younginvestor2013 I just got off the phone with Fidelity (my 401k is with Fidelity). They said that it is not possible to do a retroactive Roth 401k ---> traditional 401k change for 2017. The individual I spoke with has never been asked that but looked into it and said it was not a possibility. As a result, it does not look like I'll be able to get my taxable income low enough to avoid capital gains. So I need to decide if it is worth paying about $6k in capital gains tax to lock in some of these gains.

What if you just wait and do the sale in 2018 and do 401k contributons instead of Roth contributions to keep your income low enough to get 0% LTCG? Is that a possibility?

[younginvestor2013]

At this point, I'm not sure.

I am anticipating a $10-18k raise at work. If that happens, then it wouldn't be a possibility.

If it doesn't happen, then maybe. But I'd still have about a $3-4k gap. I'd have to come up with additional deductions other than the ones I've already mentioned. I believe the only items are charitable contributions?

[RenoJay]

Yes, I’d have down payment in a liquid account.

[younginvestor2013]

Is there a way to use Roth IRA or Roth 401k funds for downpayment on a house with no tax or penalties due?

If so, I could liquidate funds in either accounts and keep in a money market account with the intent to use those funds. Assuming I only W/D principal, I don't believe any taxes or penalties would be incurred?

But then again, I guess this goes against my whole point to lock in some gains..... since I would be just pulling out principal payment contributions. But I would be avoiding a $6k tax bill.

Am I thinking through this correctly?

[pb4uski]

It might be best to just suck it up and pay the $6k of tax.... but what about a loan from your 401k? On a Roth you can withdraw contributions but you then lose the tax-free attribute on those funds forever.

[SecondCor521]

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Originally Posted by younginvestor2013 I'd have to come up with additional deductions other than the ones I've already mentioned. I believe the only items are charitable contributions?

Did you read post #18 at all? Unless I'm missing something, it answers your question (the first time you asked it).

[Sunset]

You can cherry pick which lots of stock you sell, selling the ones that are lower in LTCG within a group of "X" stock, assuming you bought "X" stock in stages/years.

You simply look up the unrealized capital gains for each stock, and see if there is a difference by purchase date, then when you put in an order to sell it, you select which stock lot to sell instead of the normal FIFO

[brucethebroker]

If you are still concerned about taking the money and winding up in a larger tax bracket/not keeping your income low enough, why not spit the withdrawal into two tax years-'17 & '18? Take some this month, the rest in Jan. 3 week wait, but two different tax years. I used this a couple of years ago when cashing in some IRA funds.

[flintnational]

I would take reasonable steps to minimize the tax hit. However, my overriding concern would be to move any money I needed in the near term (5 years or less) out of stocks. A small CG tax hit now is better than a larger market correction loss just before you need this money.

[pb4uski]

Good point.... let's say for purposes that the current fair value of the position to be sold is $75k and you have a $30k gain and a $6k tax at 20% combined federal and state.

If you sell, you end up with $69k net.... an 8% correction wipes that our and you still have to pay tax so instead of netting $69k you will only net $65k.

[younginvestor2013]

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Originally Posted by pb4uski Good point.... let's say for purposes that the current fair value of the position to be sold is $75k and you have a $30k gain and a $6k tax at 20% combined federal and state. If you sell, you end up with $69k net.... an 8% correction wipes that our and you still have to pay tax so instead of netting $69k you will only net $65k.

This thought process most accurately describes my point of view at this point.

I've thought about liquidating shares that have smaller gains, but part of my goal is to lock in gains on shares that have substantial gains (due to having been purchased a while ago).

I could do half before 2018 and half right after the new year, I'd just be concerned about a market correction at the onset of the year. But who knows if that would occur? If I sold on 1/2, I'd probably be ok

That would also split the $6k tax bill into two years, making it much more manageable, as I'd likely only have a bill of $1,000-$1,500 each year after my other deductions are accounted for.

So If I want to capitalize (lock in) these gains over the past 4 years, it doesn't look like there is much of a way around the CG taxes that would be due. I guess I can't have my cake and eat it, too.

[RunningBum]

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Originally Posted by younginvestor2013 Does anyone have any strategies for reducing capital gains taxes, besides offsetting with losses? Since the goal is to "lock in" some gains, I don't think selling at a loss makes sense. Plus, I don't have any losses to possibly realize

I wouldn't look at it exactly this way. Rather than "locking in" gains, I think your goal should be to not have your upcoming house down payment tied up in the stock market where a downturn could ruin your plans. So in your situation it sounds like you need to sell some of your stocks to have your down payment funding in a safer place.

Which ones to sell? In my opinion, it should be based on a combination of getting rid of the ones that seem most risky and prone to drop, keeping ones that seem to be best poised to continue growing, and optimizing your tax situation. The optimization could be done by selling those with the least amount of gains, or if you have room to get them taxed at 0%, you might want to sell the biggest gainers. Certainly there may be conflict between the three factors, which is why I say some combination of them.

Note that none of this mentions "locking in" gains. That's thinking about the past. You should think forward. It may be that the best course based on the paragraph above this is indeed locking in the gains on the winners, but it might not.

[pb4uski]

Are these individual stocks or ETFs or funds? What is their general nature? You might be able to buy at the money puts on those issues or the S&P 500 to hedge your unrealized gains.

[younginvestor2013]

These are all individual ETFs purchased with Specific ID method. I've never done puts.....how do those work?

[pb4uski]

It gets complicated but I'll try to do a simple example. Let's say that you have a S&P 500 index ETF and the price per share is currently $100. When you buy a put you pay $x for the right to sell that ETF for $100 at a specified date in the future*... let's say a year to keep it simple.

If a year later the ETF trades at $110, then the put expires worthless because you wouldn't be stupid enough to force someone to buy a share worth $110 for $100. In that case, the $x you paid when you bought the put is the cost of protecting yourself from a decline in the value of the ETF.

OTOH, if a year later the ETF trades at $80 because the market has tumbled, you can "put" your share to the holder and they pay you the agreed upon strike price of $100. Your net proceeds before taxes are $100 less the $x that you paid for the put. Note, in reality you usually don't put your shares to the seller of the put... usually the put increases in value to $20 ($100 strike - $80 current share value) so you get $20 at expiration, which when combined with the $80 current value of the ETF is $100 and makes you whole for the $20 decline in the price of the ETF.

Your broker can help you with the rest.

*Some are designed that you can't settle the put until the end of the term (a European option) and others are designed so you can execute the put anytime between issuance and the end of the term (an American option).

[ulrichw]

Putting things into perspective: Those $6000 of capital gains are likely a very small percentage of the capital gains taxes you'll pay over your lifetime (I'm reading between the lines here: Your username implies you're fairly early in your investing career, and you seem to be doing well).

I wouldn't go through contortions here.

Also, as was mentioned previously in the thread this is a simple asset allocation - don't think of it as locking in gains, or reserving money for a one-time expenditure; Instead think of it as adjusting your asset allocation to a more conservative mix because you will have needs for capital in the short term.

[Curmudgeon]

As others have said, this isn't really about market timing, it's about allocation. If you expect to need the money soon, it should be allocated to a stable investment.

There are some ways to lock in your capital gains now, but realize the gain (for tax purposes) next year.

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Let's say that you have a S&P 500 index ETF and the price per share is currently $100. When you buy a put you pay $x for the right to sell that ETF for $100 at a specified date in the future*... let's say a year to keep it simple.

...but that's not one of them. The IRS will call that a 'constructive sale' and force you to take the profit, as a short term gain , THIS year if you buy puts which are in or at the money.

One of the ways to do it is with a collar... you would basically sell covered calls at a price above the current market price, and use the money to buy puts below the market price. This establishes a floor on your losses should the stock drop significantly, and also a ceiling on your profits should the stock rise significantly. To avoid the constructive sale rules, the puts and calls need to have a spread of about 20% of the stock price, and both of them should be out of the money.

Another is with a non-constructive short sale... in order to accomplish this, you
1) short the stock now;
2) close out the short within the first 30 days of next year;
3) continue to hold the stock, unprotected, for at least another 60 days, then
4) sell the stock.

At this late point in the year, this probably doesn't offer you much advantage.

I intentionally haven't provided a lot of detail here, just enough to give you some keys to do more research (and/or cosult a tax professional) on your own.

[pb4uski]

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Originally Posted by Curmudgeon ....The IRS will call that a 'constructive sale' and force you to take the profit, as a short term gain , THIS year if you buy puts which are in or at the money.....

The OP's unrealized gains are already long-term since he has mentioned that they would be at 0% or 15%, so the rule that you are referring does not apply.

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A “protective put” implies that stock was purchased previously and that puts are being purchased against an existing stock position, and protective puts can affect the holding period of the stock for tax purposes. If a stock is owned for less than one year when a protective put is purchased, then the holding period of the stock starts over for tax purposes. However, if a stock is owned for more than one year when a protective put is purchased, then the gain or loss on the stock is considered long-term regardless of whether the put is exercised, sold at a profit or loss or expires worthless.

In the OPs case, his is simply protecting his long term gains so buying an at the money put is not a constructive sale... the put gives him the right, but not the obligation to sell for $100 so it is not a constructive sale.

An example from a Forbes article:https://www.forbes.com/2010/07/30/av...l#3084e0a66aad

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No. 4. Buy a put. Example: You own some low-basis Procter & Gamble stock that your grandmother gave you. It's now trading at $61 and you can't stomach the risk it will go down a lot. Buy January 2012 put options exercisable at $60. Those options were recently trading at just under $7. They give you the right, but not the obligation, to sell P&G at $60. Let's say this blue chip crashes to $40 over the next 17 months. The option will then be worth $20. Your $13 profit on the option will soften the blow of losing $20 of your appreciation on the stock. Drawbacks: Crash insurance is expensive, and the tax rules on protective puts are somewhat unattractive. Put options are costly because they allow you to enjoy gains (P&G might go to $120) without suffering any losses. But if this stock goes sideways for a decade you are going to get poor buying options over and over again at $7 each. As for taxes: The put purchase does not get in the way of your immediate objective, which is to avoid paying cap gains taxes on the P&G appreciation. But it has its own tax issues. If the stock crashes, the put becomes valuable and you have to do something with it. You could exercise the option, delivering the shares at $60 and paying tax on the whole thing. Or you could sell just the put, realizing a short-term gain on that. If the stock goes up or sideways, the put expires worthless. You are not permitted to deduct the $7 loss on the put. Instead, the $7 gets added to your cost basis for the stock, lowering your eventual capital gain if you do sell the P&G shares. ....

Also see: https://www.fidelity.com/viewpoints/...t-your-profits

[Curmudgeon]

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Originally Posted by pb4uski In the OPs case, his is simply protecting his long term gains so buying an at the money put is not a constructive sale... the put gives him the right, but not the obligation to sell for $100 so it is not a constructive sale.

Isn't that the exact situation that the constructive sale rule was meant to cover? Protecting a gain without realizing (getting taxed on) it?

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Originally Posted by pb4uski An example from a Forbes article:https://www.forbes.com/2010/07/30/av...l#3084e0a66aad

You'll notice, in your example, that the purchased put is out of the money. Constructive sale applies to puts IN or AT the money.

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Originally Posted by pb4uski Also see: https://www.fidelity.com/viewpoints/...t-your-profits

Please read footnote 2 of that article.

OK, I'll admit I'm not a tax professional, so I may be wrong. But I advise the OP to do his own research and tread carefully.

[pb4uski]

I agree that the OP needs to do his own research and get his own tax advice, your assertion that if he buys a protective put that he has entered into a constructive sale is still questionable.

See Tax Treatment of Protective Puts on pages 5-6 of https://www.optionseducation.org/doc...ghnetworth.pdf

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In addition, unless and until Treasury regulations are published to the contrary, purchasing a put option by itself will not result in a “constructive sale” of the investor’s appreciated XYZ shares.

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19 If the option is not deep-in-the-money, the purchase of a put option with respect to appreciated XYZ stock should not be a tax realization event with respect to the underlying shares.

So if a not deep-in-the-money option is not a tax realization event, then an at-the-money option would not be either.

Be even if you were right, it would be easy enough to avoid by just buying a put option that is just slightly out-of-the-money.