The Impact of Eliminating Specific Share Identification

[Htown Harry]

We had a lively thread on a proposal in the President's budget proposal that would cap contributions to tax-deferred accounts when a balance threshold is exceeded. http://www.early-retirement.org/forums/f52/the-impact-of-a-retirement-savings-account-cap-66151.html

I came across another proposal in the budget that - if enacted - would affect those who are buying and selling securities in taxable accounts. And possibly the tax strategies of those who are pursuing capital gains / loss harvesting.

Michael Kitces' blog goes into detail. Proposal Threatens To Ban Specific Share Identification Method For Lot Level Accounting Tax Strategies - Kitces | Nerd's Eye View

We've had a thread or two that covered the relatively recent cost basis tracking requirements for brokers, and the implications. http://www.early-retirement.org/for....html?highlight=specific+share+identification

An excerpt from Kitces' blog post:

the new [ cost basis] tracking rules effectively enforce the requirement that if advisors and their clients are going to use the specific share identification method, or otherwise want to set a favorable default method of accounting, it must be chosen by the time the sale occurs and the trade settles; otherwise, the lot selection is "locked in" and cannot be changed later.

In a new potential blow to the planning strategy, though, the latest 2014 Budget Proposal from President Obama would eliminate lot level accounting and the specific share identification method altogether, requiring instead that covered securities all be reported using the average cost method once they are held long enough to be eligible for long-term capital gains. Although some of the details remain unclear - most notably, whether the rules would apply only for stocks, or for mutual funds and ETFs as well - the bottom line is that the opportunity to make tax-savvy decisions about individual investment lots being sold may soon cease to be a value proposition for advisors and the technology that supports them!

Is this a big deal, or just a new twist in the details?

 

[samclem]

Is this a big deal, or just a new twist in the details?

Thanks for this heads-up, this is the first I'd heard about the proposed change.

It could be a big deal. The main advantage of using the specific shares ID method is to allow the shaping of one's taxable income over time. Assuming (for simplicity) that all the funds in a taxable account will eventually be withdrawn over the years, the amount of taxable proceeds will be the same whether using specific ID or average cost basis. But if a person has shares of wildly different cost basis (maybe because they were purchased over many years), being able to specify which shares are being sold in each instance can allow a person to significantly reduce taxes paid, or allow the person to qualify for ACA subsidies to which he is entitled.

It might be too simple to view each of these proposed changes as an individual initiative, I think they are designed to work together to prevent "leakage" of taxable income (or to increase "fairness"). I'm sure some people see the traditional Specific Shares" method as a "tax expenditure", but to me it is exactly the opposite--it's the most straightforward and clear way of handling gains: I bought these specific things for $XX, now I want to sell them and pay the taxes.

So, is there anything that we should do now?
a) If we believe this proposal has a chance of being enacted, it might make sense to favor selling the most appreciated shares in taxable accounts while this accounting method still exists. For example: If ER Jim will have $30K in "headroom" before reaching the top of the 15% bracket, he might have a choice of either:
a) taking $30K in 72(t) withdrawals from an IRA (to convert to a Roth or to spend) --and pay the 15% tax on the $30K, or
b) Take 30K in cap gains (at 0%) on funds in his taxable accounts.

Option B might make more sense, depending on the tax rate he anticipates experiencing down the road.

I think the biggest impact will be the inability to tax-loss harvest via the specific ID method. As far as I can tell, that's not a huge deal to those under the 15% line (since they are not paying any CG anyway--the losses have zero dollar value, they just allow more room for other gains to fit under the 15% ceiling of the 15% bracket). For those in higher brackets the inability to effectively harvest losses will be more significant.

 

[MichaelB]

Is this a big deal, or just a new twist in the details?

Not a huge deal, but it can make selling a little more difficult for higher net worth investors with mostly taxable accounts hoping to leave some assets untouched until death, where they reset in cost basis.

 

[Htown Harry]

It might be too simple to view each of these proposed changes as an individual initiative, I think they are designed to work together to prevent "leakage" of taxable income (or to increase "fairness").

Not a huge deal, but it can make selling a little more difficult for higher net worth investors with mostly taxable accounts

I agree. Although this change would impact Warren Buffett as well as a Norwegian widow selling her AT&T shares, the purpose appears to be reducing deferrals of taxable income by high-income and high net worth taxpayers.

For those who are not CPA's, whether specific share identification is considered a tax deferral "trick" probably depends on your politics.

As noted in the previous thread, the details of tracking and using average cost basis figures provided by brokers has its own set of problems.

 

[Texas Proud]

I have not heard this before, but I would put it on one of those dead on arrivals proposals...


Now, if it were included in a total tax revision that some have talked about, I would think there might be a chance of passage... as part of a normal budget package... not...

 

[JoeWras]

Not a huge deal, but it can make selling a little more difficult for higher net worth investors with mostly taxable accounts hoping to leave some assets untouched until death, where they reset in cost basis.

Here's another scenario.

Harvest the loss lots for your cap gain offset purposes. Donate the gain lots to take the appreciated value as a deduction.

 

[kmt1972]

Yes. I noticed this as well. I did not mind it that much because usually when I sell, I sell all my positions pretty much in the same year so it does not impact me. I can see how it can mess other people up. As pointed out before, there are ways around this anyway for high NW people, like borrowing against your holdings when you need cash and then once you pass on your heirs can get the asset resetting the cost basis and then repay the debt.

 

[Animorph]

Seems like a needless complication for little if any gain.

My first thought, since I like specific share and avoid average cost, would be that I would set up several brokerage accounts and buy only one lot of any one ETF/fund/stock per account. Many different types of shares in one account, but only one lot of the same shares. Simple to do, with no extra cost at this time at least. Then I can sell the lot I want without averaging it with any other lots I may have.

Pretty silly having to do that, but if that's what they want I'll do it.

 

[photoguy]

My first thought, since I like specific share and avoid average cost, would be that I would set up several brokerage accounts and buy only one lot of any one ETF/fund/stock per account.

Exactly what I was thinking.

But it would make tracking my portfolio a real pain (I already have too many funds in too many accounts)..

 

[FinanceGeek]

My first thought, since I like specific share and avoid average cost, would be that I would set up several brokerage accounts and buy only one lot of any one ETF/fund/stock per account. Many different types of shares in one account, but only one lot of the same shares. Simple to do, with no extra cost at this time at least. Then I can sell the lot I want without averaging it with any other lots I may have.

Too bad they thought of that. From the Treasury Green Book, here's a quote with key sections bolded.

In fact, this proposal also appears to eliminate most tax loss harvesting.

http://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations-FY2014.pdf

The proposal would require the use of average basis for all identical shares of portfolio stock held by a taxpayer that have a long-term holding period. Thus, the provision would require that the cost of any portfolio stock sold, exchanged, or otherwise disposed of be determined in accordance with the average basis method now permitted for regulated investment company stock. The provision would apply to all identical shares of portfolio stock held by the taxpayer, including identical shares of portfolio stock held by the taxpayer in separate accounts with the same broker or with different brokers. Shares held by a taxpayer in a nontaxable account, however, such as an individual retirement account, would not be subject to the requirement to use average basis. The statute would provide the Secretary with authority to draft regulations applying the average basis method to stock other than portfolio stock. Special rules may also be required to coordinate the average basis method with the rules applicable to stock in a passive foreign investment company.

The proposal would apply to portfolio stock acquired on or after January 1, 2014.

 

[samclem]

I wonder where this would leave Tax Managed mutual funds? Selling stocks that have declined in value to offset gains is one of the big tools they use. They were already losing market share to ETFs.

It seems only right that holders of gold bullion coins get the same treatment: When you sell one, the taxable gain of that collectible is based on the average you paid for all such coins you own, not the price you paid for that particular coin.

 

[Animorph]

Too bad they thought of that. From the Treasury Green Book, here's a quote with key sections bolded.

In fact, this proposal also appears to eliminate most tax loss harvesting.

http://www.treasury.gov/resource-center/tax-policy/Documents/General-Explanations-FY2014.pdf

The proposal would require the use of average basis for all identical shares of portfolio stock held by a taxpayer that have a long-term holding period. Thus, the provision would require that the cost of any portfolio stock sold, exchanged, or otherwise disposed of be determined in accordance with the average basis method now permitted for regulated investment company stock. The provision would apply to all identical shares of portfolio stock held by the taxpayer, including identical shares of portfolio stock held by the taxpayer in separate accounts with the same broker or with different brokers. Shares held by a taxpayer in a nontaxable account, however, such as an individual retirement account, would not be subject to the requirement to use average basis. The statute would provide the Secretary with authority to draft regulations applying the average basis method to stock other than portfolio stock. Special rules may also be required to coordinate the average basis method with the rules applicable to stock in a passive foreign investment company.

The proposal would apply to portfolio stock acquired on or after January 1, 2014.

Yeah, I figured there'd be something. That makes it a lot like wash sales tracking, so not something they wouldn't do. But that kind of screws their brokerage cost basis reporting. I do have the same taxable fund shares spread all over since I keep separate accounts for DW and I as well as retirement, and have some accounts directly with fund companies while still buying some of the same shares at the brokerage. Just make it as complicated as possible...

 

[FinanceGeek]

I wonder where this would leave Tax Managed mutual funds? Selling stocks that have declined in value to offset gains is one of the big tools they use. They were already losing market share to ETFs.

Simple - these funds would have their "porky moment". Gotta believe the financial services industry would fight this rule change immensely.