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Selling an underperforming fund with lots of cap gains
Old 09-21-2016, 03:03 PM   #1
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Selling an underperforming fund with lots of cap gains

I have an active mutual fund in a taxable account that has been under performing its index in recent years by anywhere from 1 to 2% a year. I have owned this fund for years and years and have a lot of capital gains.

My plan is to sell it in stages so that I stay in the 15% income bracket and pay no capital gains taxes. It will probably take 4-6 years to do that since it depends on what other dividends are being realized.

If I sell it off all at once and pay a 15% tax on the proceeds, it will take the index fund account (now with 15% less assets) anywhere from 10 to 18 years to overcome the inertia of doing nothing. (outperforming by 1 to 2% annually).

I don't think I'll qualify for PPACA subsidy, and even if I do, it will be very small - so I'm not taking that into consideration at all.

I am 14 years away from needing to take RMDs, so I think making the change to the index fund is probably a better bet than doing IRA to ROTH conversions. I do not base this on any hard calculations, but on the reasoning that I will be better off with the additional (big assumption) earnings from the index fund over 14 years. Index funds also distribute less than the active fund, which means more control on my annual income.

I do not want to take any future tax changes into account that aren't already law.

Care to comment or advise?
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Old 09-21-2016, 03:52 PM   #2
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The goal should be to maximize your after-tax portfolio value, rather than minimize taxes. You said you hadn't done any hard calculations, but I would do so to see if you're better off selling it all now, taking the 15% LTCG, and investing better elsewhere.
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Old 09-21-2016, 04:15 PM   #3
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I dislike mutual funds as the owner has no control over when the fund declares capital gains which has really screwed up my taxes. (It's a nice problem to have, but still a problem).

OP - when are you planning to take SS, as the SS will become taxable at pretty low amounts , varies if you are single or married by a bit. If you are going to take SS early, watch out about this.

You should calculate the subsidy you are willing to give up to save 15% tax on profits, as some folks get very large subsidies.
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Old 09-21-2016, 04:33 PM   #4
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But a possible scenario is that we have a 20% correction that will make your 15% cap gain tax look very puny. Of course, if your just moving it back into the same market, you may see the 20% correction whether in the active mutual fund or in the index fund.

I have an active fund in my taxable account that has been underperforming also, but it is mostly due to its international component. I've considered selling it over time also, for the same reasons you give, but it represents a significant portion of my international exposure so I keep it for its diversification factor. May be similar reason why your fund is underperforming.
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Old 09-21-2016, 04:53 PM   #5
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RunningBum : I have done the calculations for the cap gains tax - and that points to selling till the 15% bracket. I have not done the ROTH conversion calculations.

Sunset - Index funds typically have smaller distributions than active funds. We'll probably delay SS to 70. With the subsidy, it all depends on how much my funds distribute at the end of the year and how much I have to sell too. I'm taking all expenses from taxable accounts. I'll wait till we get estimated distributions before acting.

RE2Boys: I will be buying an index fund in the same asset class.

We are ER'd and only income is from the portfolio.
Thank you.
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Old 09-21-2016, 05:50 PM   #6
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Not sure where you have it, but Fidelity has a charitable trust. You can donate part of the inflated fund to the trust for an immediate tax write off and reduce your cap gains for future selling. You still can then direct the money to the charity of your choice. It's a great tool.
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Old 09-22-2016, 09:17 AM   #7
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Not sure where you have it, but Fidelity has a charitable trust. You can donate part of the inflated fund to the trust for an immediate tax write off and reduce your cap gains for future selling. You still can then direct the money to the charity of your choice. It's a great tool.
This is what I have been doing with odd-ball holdings. I move them in a year that our tax rate is high -- for example, years we had NQ options to exercise. Once we start RMDs our rate will spike permanently so I will dump anything I have left in terms of legacy "mistake" investments with unrealized gains.
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Old 09-22-2016, 09:34 AM   #8
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Originally Posted by Sunset View Post
I dislike mutual funds as the owner has no control over when the fund declares capital gains which has really screwed up my taxes. (It's a nice problem to have, but still a problem).
If you're starting out now then sure, maybe ETFs are better to minimize distros. But OP is talking about the situation many of us are in - mutual funds bought 20-30 years ago (or more) that have lots of unrealized cap gains. You can't just switch these out for something better without planning.

I'm in the same boat with a few Fidelity funds but have decided to sit on them for now. They're all sucking wind vs. the indexes in the past year and a half but have a long-term track record of outperforming them. Stuff like Contra and Growth Co. These actives are less than 10% of my total port so it's not that big a deal.
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Old 09-22-2016, 10:40 AM   #9
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Not sure where you have it, but Fidelity has a charitable trust. You can donate part of the inflated fund to the trust for an immediate tax write off and reduce your cap gains for future selling. You still can then direct the money to the charity of your choice. It's a great tool.
Many charitable organizations have accounts at the major brokerage houses so they can receive donated shares directly. We do our donations to our university in this manner. For Fidelity, you send in an authorization letter to move xxx shares of xxx company from your account XXX to beneficiary account XXX. A quick call to your preferred charity will get you the account number.
You deduct value of shares on day of transfer. If you are using lots specific averages, you can designate the lot that has the most gain to further reduce your cap gains exposure.
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Old 09-22-2016, 11:24 AM   #10
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With an actively-managed fund that paid out distributions annually, one has paid some taxes on those distributions each year, so be careful about the calculation of the tax basis.

If one sells shares using the cost basis method of "Specific Identification" (it doesn't matter if the shares are "covered" or "non-covered"), then one can probably sell many more shares of the high cost basis purchased more recently with distributions than older shares with low cost basis purchased ages ago for a given any amount of realized capital gains.

That also means that one can donate the lowest cost basis shares to charity if one is so inclined.

Whether one is eligible to use "Specific Identification" or not will depend on whether one has ever sold shares in the past with "Average Cost" or not.
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Old 09-22-2016, 11:50 AM   #11
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Originally Posted by walkinwood View Post
....I am 14 years away from needing to take RMDs, so I think making the change to the index fund is probably a better bet than doing IRA to ROTH conversions. I do not base this on any hard calculations, but on the reasoning that I will be better off with the additional (big assumption) earnings from the index fund over 14 years....
I think that's the right approach and reasoning. I'm in a very similar situation with a "mistake" in the taxable account. It's a high-dividend ETF that follows a strange index, weights on yield, and has a high ER. I'd like to replace it with VYM, which I also own and has performed better by about 2% per year on average. However, it would take 3 years to fit the gain inside the 15% bracket, which would squeeze out Roth conversions during that period. Thus far, my approach has been to simply prioritize selling the "mistake" whenever I need to raise cash from the taxable account. This spreads the gain over a much longer period and leaves room for conversions.

However, I've come to realize that the eventual mix of LTCGs and Roth conversions over the next 15 years is unaffected either way, just shifted in time. But selling upfront would pull in the benefits of holding VYM over the "mistake." So at least in my situation, I don't think there's any lost benefit from deferring conversions (maybe some tax-free growth?). And the benefit of holding VYM gets pulled in, compared to the normal-course-of-business approach I had been taking.
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Old 09-22-2016, 01:03 PM   #12
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With an actively-managed fund that paid out distributions annually, one has paid some taxes on those distributions each year, so be careful about the calculation of the tax basis.

If one sells shares using the cost basis method of "Specific Identification" (it doesn't matter if the shares are "covered" or "non-covered"), then one can probably sell many more shares of the high cost basis purchased more recently with distributions than older shares with low cost basis purchased ages ago for a given any amount of realized capital gains.

That also means that one can donate the lowest cost basis shares to charity if one is so inclined.

Whether one is eligible to use "Specific Identification" or not will depend on whether one has ever sold shares in the past with "Average Cost" or not.
This is very important. I had a substantial holding in an actively managed fund that I'd been investing in off and on since the early 1980s. When I finally decided to sell it this year, I actually had a tax loss because of having already paid the taxes on the distributions over the years. Of course, to do this accurately, you need a record of all of your purchases over the years. You can get historical info on the share prices from Yahoo Finance, and you can probably get the distribution
info over the years from the fund company. I fortunately had gathered all of this up several years ago and built a big cost basis spreadsheet - so glad I did!
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Old 09-22-2016, 02:44 PM   #13
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This is very important. I had a substantial holding in an actively managed fund that I'd been investing in off and on since the early 1980s. When I finally decided to sell it this year, I actually had a tax loss because of having already paid the taxes on the distributions over the years. Of course, to do this accurately, you need a record of all of your purchases over the years. You can get historical info on the share prices from Yahoo Finance, and you can probably get the distribution
info over the years from the fund company. I fortunately had gathered all of this up several years ago and built a big cost basis spreadsheet - so glad I did!
+1
Wow .... I'm so used to ETF's I totally forgot, but you are correct.
OP - has probably been declaring and paying tax on his/her mutual fund each year. I know as DW had a mutual fund and it would tell us how much we had to declare each year and pay taxes upon.

So basically it's possible if OP just sold the entire thing, OP's tax bill would be negligible, of course OP will have to include the declared capital gain for this year as well that happened or should have happened at the 6 month interval.
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Old 09-23-2016, 11:45 AM   #14
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Thanks all for your comments.
- the amounts are too large for me to go the charitable trust route at this time. Something to keep in mind for the future though.
- I do have records and know the cost basis calculations needed. My gains take these into account.
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