Time to take capital gains?

[Surfdaddy]

I was waiting until after the end of the year to sell some fund holdings and move money around to adjust my portfolio. I figured I had done enough this year (incurring enough extra tax liability) and I would "spread it around" into 2007.

With the Democratic congress, I'm reconsidering that approach. I'm thinking that perhaps I should just eat the extra capital gains this year, as sooner or later I'm guessing the CG rate is going to go up. It may not happen in 2007, but if it did I'd be kicking myself...

What does everybody else think?

 

[BOBOT]

You only have to wait until 1/1/07; nothing's going to change before then. And I think it's not a good idea to let tax issues drive your investment approach anyway.

 

[Craig]

Agreed the tax tail shouldn't wag the dog, but ... if you were thinking of selling that asset anyway, I think you're right to presume cap gains taxes will be rising. Investors may not be treated kindly by the new perspective in DC.

 

[brewer12345]

I think you'll have a long time to reconsider cap gains taxes, since it seems unlikely that the Democrats will have the votes to repeal reduced cap gains taxes any time in he next two years, assuming taht's what they plan to do.

I can think of one reason you'd bother rebalancing ahead of schedule: when an allocation has gotten so far out of balance that it is affecting your portfolio's risk profile.

 

[audreyh1]

I don't think the democrats have enough of a majority to raise the capital gains tax yet. They can't override a Bush veto, and they may choose to tread softly on raising taxes before the 2008 elections anyway.

I'd be more worried about 2009 and onwards.

The current rates are set to expire in 2010, and it seems less likely that they will be renewed past then.

Audrey

 

[tryan]

With the Democratic congress, I'm reconsidering that approach.

What's the worry? The Senate is split and they don't have the Whitehouse. Nothing will happen in this GRIDLOCK. The real vote is 2 years away.

 

[lazyday]

By the way, there's a related discussion at the Diehards board.

Does anyone remember/know if cap gains rate increases have been retroactive before? Trying to judge how likely I'll have advance notice.

In other words, if a law that increases rates gets passed in 2007, it might be set to increase rates starting Jan 1 2008, retroactive to Jan 1 2007, or sometime close to when debate on the law was coming to a close. What's happened in the past?

 

[ESRBob]

I know this thread came and went, but I couldn't find any other one dealing with the upcoming 3 years (2008, 2009, 2010) of zero percent capgains taxes for people in the 15% income bracket. It feels like it should be more significant than we've acknowledged here.

a) couples with taxable income up to $63,700 qualify for the 15% income tax bracket and zero percent capgains, (and we all know you can get a lot more spending money than $63,700 in a year without actually having taxable income reach that level)

b) it won't help Roth conversions -- that income is ordinary income -- but it could certainly help anyone who needs to do meaningful rebalancing in a portfolio and has been putting it off due to tax consequences.

c) I think no way will Dems take this away, since it is explicitly targeted at helping their core constituency of lower income, working poor, elderly pensioner taxpayers -- ERs get to tag along on these groups benefits .

Still, I can't quit find the killer benefit here for ERs -- does anyone else see scenarios or benefits I'm missing?

 

[Martha]

There actually was an article on this in the WSJ today. One thing the author suggested was gifting appreciated stock to children who could then cash it in at the low capital gains rates and use the money for college. This was specifically geared towards people who would not be getting financial aid.

 

[teejayevans]

I know this thread came and went, but I couldn't find any other one dealing with the upcoming 3 years (2008, 2009, 2010) of zero percent capgains taxes for people in the 15% income bracket. It feels like it should be more significant than we've acknowledged here.

Still, I can't quit find the killer benefit here for ERs -- does anyone else see scenarios or benefits I'm missing?

Yea, for those of us with stock and are going to retire in e/o 2007, this is a big bonus.
Does anybody know if you exceed the threshold, will is be all or nothing? It sounds like
it, and some planning might be in order to prevent exceed the thresholds.
In other words, if I sell stock and the gains put me 10$ over the income bracket limit, do
I pay the gains on just the 10$ or does all the gains get taxed at the normal rate?

Tom

 

[grumpy]

This may work for us in 2008. My DD earns very little in her job as wig supervisor for a touring Broadway show and is well below the 15% threshold. She still owes quite a bit on student loans. We have over $100k in a taxable mutual fund that we have owned for more than thirty years with sizable capital gains over that time. We are considering gifting her shares up to the $12,000 gift tax exclusion limit ($12K from each of us) so she can sell the shares, pay no cap gains tax and pay off her remaining student loans.

It would be tempting in subsequent years to try to have her sell more gifted shares and somehow quietly return the $ to us so we could rebuy the same fund but I think the IRS would probably frown on that.

Grumpy

 

[Nords]

It would be tempting in subsequent years to try to have her sell more gifted shares and somehow quietly return the $ to us so we could rebuy the same fund but I think the IRS would probably frown on that.

She could always gift it back!

 

[JohnEyles]

In other words, if I sell stock and the gains put me 10$ over the income bracket limit, do
I pay the gains on just the 10$ or does all the gains get taxed at the normal rate?

I very (extremely) seriously doubt the latter. The tax code does not tend to have such
non-linearities built into it. For one thing, it would tend to provide an extreme
incentive for cheating. It's a common misconception that people have that when
they "go into the next tax bracket" that the higher tax bracket somehow applies to
the income that was below the level that put them into the next bracket. Simply
look a random tax table (I believe this is "single" for 2007):

Taxable income: Tax:
Over But not over Tax +% On amount over

$ 0 $ 7,825 $ 0.00 10 $ 0
7,825 31,850 782.50 15 7,825
31,850 77,100 4,386.25 25 31,850
77,100 160,850 15,698.75 28 77,100
160,850 349,700 39,148.75 33 160,850
349,700 ....... 101,469.25 35 349,700

Note that when taxable income goes over $31,850 (for example),
the portion over $31,850 gets taxed at 25%, but the portion below
$31,850 continues to get taxed at the lower 10% or 15% rate.

It's possible this special cap-gains rate for 2008 behaves differently,
but I think it's extraordinarily unlikely.

 

[ESRBob]

Grumpy--
very creative -- I think there are possibilities here. The idea is that she can sell at low/zero capgains rates and you can't. So gifting to her for the sale, and then having her regift cash back to you, with a full market basis becomes interesting.

Since you can use up a million each in gifting during your lifetimes, you could do it faster.
The only risk there would seem to be that you are both (you and your daughter) using up your lifetime gift exemptions to simply return yourselves to square one.

As a single, she hits her normal capgains threshold once taxable income hits 31,850. She could get a lot more income than that -- it's after deductions that the number has to be under 31850.

I dunno ... it may seem like a lot of work for a little payoff, but I don't see anything illegal -- maybe someone else does. Then again, your daughter needs the $ so the temptation might be to not ask for it back, which is a whole different issue...

 

[AlmostDone]

This is something (among a lot of financial stuff) that I did not know. So, I have some stock that my grandmother gave me before she died. Because it was before she died, I believe my cost basis has to be what she paid for it, so the capital gains will be high. If I sell this in 2008, if our income has gone down below 67k due to retirement, I don't have to pay any capital gains on it? Why 2008?

 

[Martha]

AlmostDone, if the capital gains put you into the 25% bracket, then those excess gains will be taxed at the 15% higher rate rather than the 0% rate.

Currently the rates on long-term capital gains is 15% for taxpayers in the 25% bracket or higher and is 5% for individuals in the 10% and 15% tax brackets. In 2008 through 2010, the 15% rate remains the same but the 5% rate drops to 0%. After 2010, the capital gain rates will return to the old 20% and 10% rates, and the five-year holding period rules and rates return.

 

[donheff]

This is something (among a lot of financial stuff) that I did not know. So, I have some stock that my grandmother gave me before she died. Because it was before she died, I believe my cost basis has to be what she paid for it, so the capital gains will be high. If I sell this in 2008, if our income has gone down below 67k due to retirement, I don't have to pay any capital gains on it? Why 2008?

Doesn't a stock gift get kicked up in basis to current value at the time of gifting just like an estate? Or does that apply only to gifts to kids?

 

[Martha]

Doesn't a stock gift get kicked up in basis to current value at the time of gifting just like an estate? Or does that apply only to gifts to kids?

No, the basis is the basis of the giver. Even if the gift is to a kid. Step up in basis only results from transfers at death.

 

[Nords]

Currently the rates on long-term capital gains is 15% for taxpayers in the 25% bracket or higher and is 5% for individuals in the 10% and 15% tax brackets. In 2008 through 2010, the 15% rate remains the same but the 5% rate drops to 0%.

Here's the dumb question, which pops up whenever I have to choose whether to calculate my income tax from the tax tables or from the special worksheet:

Let's say that 2008's dividing line between the 15% & 25% income brackets is $65,000. You add up all your W-2s & 1099-Rs & interest, and after taking whatever deductions & exemptions, your taxable income is $65K. You had no other distributions or qualified dividends or cap gains, so your income tax is calculated right out of the tax tables.

Now let's say that you sell a mutual fund and incur an additional long-term capital gain of $50K. Since all your other taxable income was $65K, is the cap gain taxed at 0% or at 15%?

 

[Martha]

15%.

 

[ESRBob]

Unless you made some (ahem) suboptimal trading decisions in 2000-2002 and are sitting on a pile of long term capital loss carryforwards. (moi??!)

 

[Leonidas]

...suboptimal trading decisions...

Yet another phrase I have decided to make my own. Of course I would prefer to use it more often in regard to someone else's returns rather than mine.

 

[Nords]

Unless you made some (ahem) suboptimal trading decisions in 2000-2002 and are sitting on a pile of long term capital loss carryforwards. (moi??!)

"Sorry"... already wiped those out with subsequent gains!

 

[ESRBob]

So either you didn't make nearly enough dumb decisions in the trough years, or you're trading too much in the good years?

One thing about the mutual fund buy & hold, annual rebalance thing is that it reduces realizing capital gains, but I've never seen a study that could quantify that vis-a-vis an individual stock buy-and-sell approach. Anybody seen any?

In the absence of any studies, it might be interesting for Nords or any other active stock and bond traders here to calculate what percent turnover they have over the course of the year -- the total asset sales divided by the value of the portfolio 12/31/06. I'll do the same with my mutual fund annual rebalance approach (I should be doing it within a week or two) and we can see how they compare. In both cases we need to make sure we count dividends, capital gains and other distributions as part of that turnover.

 

[Nords]

So either you didn't make nearly enough dumb decisions in the trough years, or you're trading too much in the good years?

I enjoyed the '90s runup in mutual funds and didn't start trading stocks until Dec 2000 with a slug of QQQQs at $61/share. Luckily I was skittish, used tight sell stops, and put a lot of money into Apple in 2001.

In the absence of any studies, it might be interesting for Nords or any other active stock and bond traders here to calculate what percent turnover they have over the course of the year -- the total asset sales divided by the value of the portfolio 12/31/06.

Qualitatively I'd say my turnover is a fraction of the styles I was experimenting with during 2001-2002. I started out like a hyperactive bunny but I've slowed way down.

As for the numbers, gimme a few weeks to dig through a couple other projects first.