Zero Tax Capital Gains Strategy

[haha]

p.s. My carry-over loss was not necessarily the result of bad investments such as Ha suggests with his car depreciation example.

In my case I bought high, then the market corrected. I sold before the end of the year to book the loss than repurchased the shares after 30 days to reestablish my position in the security.

I didn't really mean to suggest it was the result of bad investing. One takes these losses is a tax-strategic decision. Still, shouldn't they have run off fairly soon after? I compare it to a non-taxable account. If you buy something, and it goes down, you can decide that it was bad buy, or that it was a good buy but the timing was bad, or it was good and the timing was good but Fortuna was not with you. If you still like it as much as before, you keep it, since there is taxation to consider. But no mater how you look at it, your position would not ordinarily seem as good as it might have been had the stock you bought not gone down.

If you sell ABC Corp at a loss, and then buy it back at the same price in an IRA you have spun some wheels and lost some money. If you do the same thing in a taxable account, you get a tax write-off, and you new shares have a lower basis than before, which if you sell them under the same tax regime will cause you to pay more capital gains tax than you would have had you kept and sold the original shares after they had come back into the same gain territory. But you have gotten a time value of money advantage, so it is usually worth the trouble. I do this regularly, but I also consider it getting some help after I had made what seems certainly to have been a suboptimal purchase decision.

Ha

 

[2B]

This article does a good job of explaining the benefits of LTCG and ordinary income manipulation. After 2015, I'll be able to have whatever income I want after a bit of small pensions. I had planned on maximizing Roth conversions until age 70 to suppress RMDs. I'll revisit this assumption and balance this with the potential for taking capital gains at 0% or 15%. Roth conversions can still be done after 70 1/2 but they need to be over and above the RMD.

 

[RunningBum]

Unless I am misunderstanding something, isn't being pleased by huge losses that seems to stretch on forever similar to being pleased about buying an expensive car to depreciate in your real or phony business?

In any case, the tax effect represents money you have already burned.

Ha

You must've missed the thread this summer where someone called the cap loss carryover a "yummy free lunch".

http://www.early-retirement.org/forums/f28/how-to-minimize-my-tax-72880.html#post1472729

 

[karluk]

You must've missed the thread this summer where someone called the cap loss carryover a "yummy free lunch".

http://www.early-retirement.org/forums/f28/how-to-minimize-my-tax-72880.html#post1472729

Making vague claims like getting a "yummy free lunch" without running the numbers to see what's really happening doesn't impress me much. Yet it's a fact that tax loss harvesting can produce a profit out of thin air, using assumptions that were definitely true for me starting in 2008 and are likely to be true for many other investors as well. One needs to assume that the loss is temporary - that stock prices will sooner or later rebound, just as they always have in the past - and that the investor will use the time until the rebound to get as much money into a Roth IRA as possible.

As a simple proof of concept, consider a taxable investment with a $3,000 unrealized loss at the end of one year that subsequently gains $3,000 the next year. The investor who sits on his hands and does nothing gets no tax deduction in the first year and sits at the end of the second year with a taxable investment that has no net gain or loss. Contrast this with the investor who realizes the loss before the end of the first year, gets the $3,000 tax deduction and uses the money raised by the tax loss harvesting to fund next year's Roth IRA contribution, purchasing similar securities to what he sold at a loss. By the end of the second year, he has a $3,000 profit, but it's all inside the Roth so there is no tax liability at all. In comparison to the investor who did nothing and comes out exactly even in both taxes due and portfolio value, the investor who harvested the loss has the same portfolio value, but has profited by the $3,000 tax deduction, worth $450 in the 15% tax bracket.

I used this strategy of aggressively transferring assets from my taxable accounts into my Roth accounts starting in 2009, getting a subsidy in the form of larger income tax returns for three years. It's over now, but it was fun while it lasted. I now have only a small amount remaining in the taxable part of my portfolio, so the same situation is unlikely to repeat for me on the same scale, even if we have another meltdown like 2008.

 

[karluk]

Incidentally, "aggressively transferring assets from my taxable accounts into my Roth accounts" means fully utilizing Roth IRA contributions, and also maxing out Roth contributions to 457 plans. Doing this for both myself and DW allowed us to get over $50k in new money every year into Roth accounts. For those people who are still working but don't have a Roth option in their 401k, it would take a lot longer to transfer assets from taxable to Roth.

 

[RunningBum]

As a simple proof of concept, consider a taxable investment with a $3,000 unrealized loss at the end of one year that subsequently gains $3,000 the next year. The investor who sits on his hands and does nothing gets no tax deduction in the first year and sits at the end of the second year with a taxable investment that has no net gain or loss. Contrast this with the investor who realizes the loss before the end of the first year, gets the $3,000 tax deduction and uses the money raised by the tax loss harvesting to fund next year's Roth IRA contribution, purchasing similar securities to what he sold at a loss. By the end of the second year, he has a $3,000 profit, but it's all inside the Roth so there is no tax liability at all. In comparison to the investor who did nothing and comes out exactly even in both taxes due and portfolio value, the investor who harvested the loss has the same portfolio value, but has profited by the $3,000 tax deduction, worth $450 in the 15% tax bracket.

I used this strategy of aggressively transferring assets from my taxable accounts into my Roth accounts starting in 2009, getting a subsidy in the form of larger income tax returns for three years. It's over now, but it was fun while it lasted. I now have only a small amount remaining in the taxable part of my portfolio, so the same situation is unlikely to repeat for me on the same scale, even if we have another meltdown like 2008.

Are you saying that if you don't have a loss to harvest, you don't fund your Roth? Most people would find a way to fund their Roth either way, making them separate events.

 

[karluk]

Are you saying that if you don't have a loss to harvest, you don't fund your Roth? Most people would find a way to fund their Roth either way, making them separate events.

Not at all. I'm saying that if I didn't have losses in my taxable accounts, it would have incurred a prohibitively expensive tax bill to put hundreds of thousands of dollars into Roth accounts while cashing in taxable investments for living expenses. We were able to do so while remaining in the 15% tax bracket, and have now enjoyed some five years of tax free growth of the six figure amount I added to the Roth when I had a chance.

Doing this in, say, 2007, when I had massive unrealized gains in my taxable accounts would have quickly put us into the 25% tax bracket. Back then I contented myself with maxing out the relatively small contribution limits of our Roth IRAs, just as many others do. That sort of small potatoes move helped, but wasn't the life changing financial event that the post 2008 moves turned out to be.

 

[RunningBum]

Not at all. I'm saying that if I didn't have losses in my taxable accounts, it would have incurred a prohibitively expensive tax bill to put hundreds of thousands of dollars into Roth accounts while cashing in taxable investments for living expenses. We were able to do so while remaining in the 15% tax bracket, and have now enjoyed some five years of tax free growth of the six figure amount I added to the Roth when I had a chance.

Doing this in, say, 2007, when I had massive unrealized gains in my taxable accounts would have quickly put us into the 25% tax bracket. Back then I contented myself with maxing out the relatively small contribution limits of our Roth IRAs, just as many others do. That sort of small potatoes move helped, but wasn't the life changing financial event that the post 2008 moves turned out to be.

I don't understand. Did you somehow get around the contribution limits of the Roth IRA by taking capital gains losses? I don't see how you do this.

Also, I don't understand how taking capital gains push you into the 25% tax bracket, unless they are short term gains.

I do understand that liquidating holdings with capital losses gives you some money to live off of. Still, the ideal is to make money on your investments, and deal with a % of it being taxed. If you do lose money on some investments, there's some consolation in that you can reduce the losses a bit with good tax management.

 

[karluk]

I don't understand. Did you somehow get around the contribution limits of the Roth IRA by taking capital gains losses? I don't see how you do this.

Please read my earlier post about maxing out both Roth IRAs and Roth contributions to 457 plans.

Also, I don't understand how taking capital gains push you into the 25% tax bracket, unless they are short term gains.

Isn't that a big piece of what is covered in the Kitces article? Capital gains are added to AGI, even if they wind up being taxed at 0%. Realizing large enough gains will push you into the 25% tax bracket, at which point part of your gains will start being taxed at the 15% rate that is applicable to tax payers who stray into the 25% bracket.

I do understand that liquidating holdings with capital losses gives you some money to live off of. Still, the ideal is to make money on your investments, and deal with a % of it being taxed. If you do lose money on some investments, there's some consolation in that you can reduce the losses a bit with good tax management.

The ideal is never to lose money, true. Whether it's attainable by investors in the real world it more debatable. I know from other threads that you are more willing to try market timing than I am and that you were very successful in navigating through the crash of 2008. Good for you, but I was not so lucky. I had large capital gains turn into large capital losses within the space of a year. Given the unfortunate reality of my situation at the time, I did succeed in finding a way to turn the tax laws to my advantage and profit from the subsequent rebound in a HIGHLY tax free manner.

Good tax management is not only applicable to those who hold investments in taxable accounts. It still applies to me, even though almost all of my portfolio is either Roth or tax deferred. My current goal is to look into ways to get future losses happen more in my tax deferred accounts than my Roth. I recently started a thread about "market timing using asset location" on the subject, but so far haven't seen any strategy that will work without me making a good prediction of future stock market performance.

 

[RunningBum]

Please read my earlier post about maxing out both Roth IRAs and Roth contributions to 457 plans.

OK, I missed that. 457 was never available to me.

Isn't that a big piece of what is covered in the Kitces article? Capital gains are added to AGI, even if they wind up being taxed at 0%. Realizing large enough gains will push you into the 25% tax bracket, at which point part of your gains will start being taxed at the 15% rate that is applicable to tax payers who stray into the 25% bracket.

No, you misread that. The only mention I see of the 25% bracket is example 3, when regular income + conversions pushed the sample person into the 25% bracket, and all cap gains on top of that were taxed at 15%. Cap gains are "added" to AGI only to the extent of pushing income over the top of the 15% bracket such that some or all capital gains are taxed. It won't actually push other income from the 15% bracket to the 25% bracket. As I almost always say when this topic comes up, it is worth understanding how the Qualified Dividend and Capital Gains Worksheet on your taxes works.

The ideal is never to lose money, true. Whether it's attainable by investors in the real world it more debatable. I know from other threads that you are more willing to try market timing than I am and that you were very successful in navigating through the crash of 2008. Good for you, but I was not so lucky.

You must have me confused with someone else. I am not a market timer at all. I've commented that I'm not against market timing as I know some people make it work, but I'm not one of them. I lost a lot in the dotcom bubble burst in 2001, and since then gradually changed my strategy from individual stocks to mostly index funds, and included some bonds, but that was a fundamental change in my plan rather than timing. I stick pretty closely to a consistent age-based AA now.

 

[karluk]

No, you misread that.

No I didn't. There is nothing in my post that is any different than Kitces' example 3 - allow LTCG and other income to push you into the 25% tax bracket and some of your gains will be taxable at 15%. That's what I said, and that's what Kitces' example says.

You must have me confused with someone else. I am not a market timer at all. I've commented that I'm not against market timing as I know some people make it work, but I'm not one of them. I lost a lot in the dotcom bubble burst in 2001, and since then gradually changed my strategy from individual stocks to mostly index funds, and included some bonds, but that was a fundamental change in my plan rather than timing. I stick pretty closely to a consistent age-based AA now.

Please accept my apologies. I did confuse you with sombody else. I have been posting here long enough to think that I know the other members failry well, but I guess I'm overestimating my ability to associate internet handles with the people and behavior behind them.

 

[RunningBum]

No I didn't. There is nothing in my post that is any different than Kitces' example 3 - allow LTCG and other income to push you into the 25% tax bracket and some of your gains will be taxable at 15%. That's what I said, and that's what Kitces' example says.

Read it again. In that example the person was in the 25% bracket with just regular income and conversions. Try out different scenarios with a tax program to see it for yourself, paying attention to the worksheet I mentioned. LTCG will not push you into the 25% bracket.

Please accept my apologies. I did confuse you with sombody else. I have been posting here long enough to think that I know the other members failry well, but I guess I'm overestimating my ability to associate internet handles with the people and behavior behind them.

No problem.

 

[aim-high]

Read it again. In that example the person was in the 25% bracket with just regular income and conversions. Try out different scenarios with a tax program to see it for yourself, paying attention to the worksheet I mentioned. LTCG will not push you into the 25% bracket.


No problem.

Perhaps this will help.

"How are long-term capital gains taxed if the gain pushes income into a new tax bracket?"

united states - How are long-term capital gains taxed if the gain pushes income into a new tax bracket? - Personal Finance & Money Stack Exchange

 

[M Paquette]

Even if you are in a low bracket with a 0% capital gains tax rate, there are other advantages to having harvested tax losses. The losses let you offset capital gains to keep recognized income below tax credit thresholds, for example.

For those folks using a tax credit subsidy to help cover the cost of medical insurance, for example, minimizing realized capital gains from the portfolio end-of-year distribution can save them from an unpleasant tax surprise if the gains would otherwise have put them over the threshold for modified adjusted gross income.

Don't forget to consider these items in addition to the basic tax brackets.


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[karluk]

LTCG will not push you into the 25% bracket.

Not true. LTCG will put you in the 25% tax bracket, causing a bump up in the LTCG rate from 0% to 15%. The 0% rate applies only to taxpayers in the 10% and 15% brackets. If you exceed those brackets, some LTCG get taxed at 15%. I would encourage you to run this through tax software yourself, because I do so every year and always get the same result. Last year, for example, my schedule D gains were included in form 1040 on line 13 and were one of the items added together to produce AGI on line 37. But I had carefully calculated what my AGI would be and adjusted my realized LTCG to conform, so I stayed just slightly below the AGI that would have put me into the 25% tax bracket and all of my gains were taxed at 0%.

 

[RunningBum]

Not true. LTCG will put you in the 25% tax bracket, causing a bump up in the LTCG rate from 0% to 15%. The 0% rate applies only to taxpayers in the 10% and 15% brackets. If you exceed those brackets, some LTCG get taxed at 15%. I would encourage you to run this through tax software yourself, because I do so every year and always get the same result. Last year, for example, my schedule D gains were included in form 1040 on line 13 and were one of the items added together to produce AGI on line 37. But I had carefully calculated what my AGI would be and adjusted my realized LTCG to conform, so I stayed just slightly below the AGI that would have put me into the 25% tax bracket and all of my gains were taxed at 0%.

I give up. I'll just encourage anyone looking to control their cap gains or income from Roth conversion to run scenarios in a tax program, paying special attention to how the QD & CG tax worksheet works to understand when CGs become taxed at 15%. It's especially important for Roth conversions because when you go over the 15% bucket, it causes the additional conversion to be taxed at 15%, and also pushes the same amount of LTCG to be taxed at 15%.

 

[karluk]

I'll just encourage anyone looking to control their cap gains or income from Roth conversion to run scenarios in a tax program, paying special attention to how the QD & CG tax worksheet works to understand when CGs become taxed at 15%.

Sure, running different scenarios and understanding the QD/CG worksheet is a tremendous boost to one's understanding of the tax laws. It should convince anyone who is familiar with it to realize that LTCG are taxed at 0% as long as taxable income remains in the 15% bracket, after which the LTCG rate jumps to 15%. Looking specifically at the QD/CG worksheet, whether one exceeds the 15% tax bracket is determined by the number entered on line 8, which is the top of the 15% bracket for various filing statuses. If that amount is larger than taxable income from form 1040, line 43, then all LTCG are taxed at 0%, which is QD/CG worksheet line 11. If your taxable income has strayed into the 25% bracket, the calculations continue past line 11, and you will eventually report some LTCG on the QD/CG worksheet line 20. That's the amount that gets taxed at 15%.

Believe me, I know that worksheet well. I have to use it every year, both when I'm filing tax returns and when I'm doing year end tax planning.

 

[RunningBum]

Sure, running different scenarios and understanding the QD/CG worksheet is a tremendous boost to one's understanding of the tax laws. It should convince anyone who is familiar with it to realize that LTCG are taxed at 0% as long as taxable income remains in the 15% bracket, after which the LTCG rate jumps to 15%. Looking specifically at the QD/CG worksheet, whether one exceeds the 15% tax bracket is determined by the number entered on line 8, which is the top of the 15% bracket for various filing statuses. If that amount is larger than taxable income from form 1040, line 43, then all LTCG are taxed at 0%, which is QD/CG worksheet line 11. If your taxable income has strayed into the 25% bracket, the calculations continue past line 11, and you will eventually report some LTCG on the QD/CG worksheet line 20. That's the amount that gets taxed at 15%.

Believe me, I know that worksheet well. I have to use it every year, both when I'm filing tax returns and when I'm doing year end tax planning.

OK, just to see if we're on the same page but saying it differently.

If all income combined exceeds the 15% bucket, divs and/or LTCG overflow and the part that overflows is taxed at 15% rather than 0%. We seem to agree here.

But the tax bracket is still 15% for the other income, line 8, which is line 43 less LTGT and qualified dividends, assuming we are still talking about someone with some CGs still taxed at 0% and some pushed into 15% (edit to say 15%, not 25%). Nothing is in the 25% bracket. This is where I'm not sure we're in agreement.

 

[karluk]

OK, just to see if we're on the same page but saying it differently.

If all income combined exceeds the 15% bucket, divs and/or LTCG overflow and the part that overflows is taxed at 15% rather than 0%. We seem to agree here.

But the tax bracket is still 15% for the other income, line 8, which is line 43 less LTGT and qualified dividends, assuming we are still talking about someone with some CGs still taxed at 0% and some pushed into 25%. Nothing is in the 25% bracket. This is where I'm not sure we're in agreement.

I think we are basically in agreement, which is actually something I've thought ever since this discussion began. Straying into the 25% tax bracket affects the tax on LTCG, not on ordinary income (unless of course the ordinary income itself exceeds the top of the 15% bracket).

The puzzling thing to me is why you ever convinced yourself that I was saying anything different. Looking over my posts in this thread, I never even came close to saying that even a single dollar of income gets taxed at a 25% rate, yet you seem to have convinced yourself that I was asserting this. Perhaps we have a different understanding of the definition of "tax bracket". To me (and I believe to the IRS as well) it's simply a comparison of your taxable income on form 1040, line 43, with an upper bound. If you're above the top of the 15% bracket, you're in the 25% bracket. That has nothing to do with the actual tax you'll pay, which is determined strictly by going through the tax forms and figuring out your liability.

 

[RunningBum]

From my perspective, if nothing is taxed at 25%, then you aren't in the 25% bracket, and conversely, if you are in the 25% bracket, then some income is taxed at 25%. We are just looking at this differently in terminology. The numbers are the same.

 

[pb4uski]

I give up. I'll just encourage anyone looking to control their cap gains or income from Roth conversion to run scenarios in a tax program, paying special attention to how the QD & CG tax worksheet works to understand when CGs become taxed at 15%. It's especially important for Roth conversions because when you go over the 15% bucket, it causes the additional conversion to be taxed at 15%, and also pushes the same amount of LTCG to be taxed at 15%.

You are correct. I have a 2013 pro forma return where the TI is exactly $72,500 (top of the 15% tax bracket). If I then add $1,000 of ordinary income in the form of more Roth conversions, the tax increases by $300 (30%). Interestingly, if I add $1,000 of LTCG, then the tax only increases by $100 (10%).

 

[teejayevans]

Informative

To extend a bit on saving taxes thought....If you retire at 55 and have 62k or less 0% taxed dividends or capital gains. And you are capable to supply any other money you need from cash. Lets say another 38k a year.

Then you can live on 100k a year, pay no federal taxes and collect Health Insurance subsidies . In the way you collect from Federal Government.

No you won't qualify for subsidies or even ACA, the long term gains may not be taxed, but they show up in your MAGI, which is what is used.


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[RunningBum]

No you won't qualify for subsidies or even ACA, the long term gains may not be taxed, but they show up in your MAGI, which is what is used.

Sure you will. 62K is the subsidy level for married couples. The other 38K is not income in that example. It's cash that was there before, or maybe from selling a 38K investment that had a 38K basis.

 

[teejayevans]

Sure you will. 62K is the subsidy level for married couples. The other 38K is not income in that example. It's cash that was there before, or maybe from selling a 38K investment that had a 38K basis.

From the original quote I took the 100k as income, and at 62k, that's not much of a subsidy, but at least it gives you an option


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[kaneohe]

OK, just to see if we're on the same page but saying it differently.

.

Glad you guys got that all sorted out.......peacefully too
Just to let you know there's at least 2 folks in the world who use that 25% bracket terminology for taxable income......just for the purposes of determining whether some of the LTCG/QDIV are subject to 15% taxation and not necessarily meaning any income gets subject to that 25% rate.

In the real world, it is very easy to misunderstand mere words describing the taxation of LTCG/QDIV so it is definitely very useful to use specific numerical examples in conjunction with the picture of LTCG/QDIV floating on top of ordinary income before deciding you have a disagreement.