Wash Rule and Capital Gains/Loss Carryover Clarity

[RetiredAt49]

BACKGROUND

I have (almost) convinced my spouse that we need to break free from our wealth management company (WMC).

Currently our WMC has our taxable brokerage account invested in 100% equities and more specifically this account is spread across about 80 individual stocks (like Apple, Microsoft, etc.). This account was setup and stocks purchased last year (although some minor rebalancing has happened).

QUESTIONS
1) If I sale everything in this account (all individual stocks) and purchase ETF’s (e.g. VTI), am I going to run into issues with the IRS wash sale rule?
2) If we sold everything, we’d take about a $400,000 loss. Note however that we would immediately turn around and purchase low cost index funds like VTI. Can I use the $400,000 capital loss this year (and in the years to follow) to offset capital gains? Is there a limit?
3) Given that we are considering the popular 3 fund portfolio strategy, would we be missing out on future tax loss harvesting strategies by putting all of our eggs in 3 ETF’s (and all at the same time and cost basis)?

 

[COcheesehead]

1. No
2. Yes, losses are matched against gains and if there is an overage, they carry forward. The losses carry forward until depleted. $3000 of which can be applied to ordinary income in any one year.
3. You can tax loss harvest from ETFs as long as you do not reinvest in a similar ETF.

 

[Out-to-Lunch]

1) No. Those securities are not substantially identical. IMHO, it is not even close: https://www.morningstar.com/articles/1045354/wash-sale-challenge-what-is-substantially-identical

2) Yes, you can (actually, must) use those losses to offset any realized capital gains. There is no limit. If not used, you may carry these losses forward to future years, indefinitely. You can (must) offset $3,000 in ordinary income each year. (But you have 133 years worth! Hopefully, you will have some capital gains to offset some year!)

3) Yes, I suppose using a simple portfolio will limit your future TLH opportunities. But, with $400k losses in the bank, I am not sure I would worry about that if the 3-fund approach meets your other needs.

 

[RetiredAt49]

Appreciate the responses thus far… so by way of an example Let’s assume then I sale all my individual stocks (which would be a $400,000 capital loss) and purchase $2,000,000 worth of VTI tomorrow. Assuming the bear market continues, could I sale all of my VTI in 3 months and purchase SCHB (or similar) and have another capital loss (assuming VTI continues to drop over those 3 months) and leverage the initial $400,000 loss plus the lost I would incur selling VTI?

If that’s the case, why doesn’t everyone perform tax lost harvesting and thus never have to pay taxes on capital gains equal to the amount of their loss? This definitely makes bear markets seem like gold mines.

 

[SevenUp]

Appreciate the responses thus far… so by way of an example Let’s assume then I sale all my individual stocks (which would be a $400,000 capital loss) and purchase $2,000,000 worth of VTI tomorrow. Assuming the bear market continues, could I sale all of my VTI in 3 months and purchase SCHB (or similar) and have another capital loss (assuming VTI continues to drop over those 3 months) and leverage the initial $400,000 loss plus the lost I would incur selling VTI?

Based on VTI vs SCHB ETF Comparison, those do not appear "substantially identical" (e.g., due to the large difference in number of holdings).

Two different funds would have to be "substantially identical" (not just similar) for a sale of one and purchase of the other to cause a wash sale. The IRS has not defined "substantially identical."

If that’s the case, why doesn’t everyone perform tax lost harvesting and thus never have to pay taxes on capital gains equal to the amount of their loss? This definitely makes bear markets seem like gold mines.

You'll have to ask everyone....

One thing: not everyone will have losses that large.

 

[clifp]

You'll have to ask everyone....

One thing: not everyone will have losses that large.

Exactly, at this stage in the bull market, It is pretty hard to sell an entire portfolio and get that large of a capital loss.

I think you are making a wise move in getting rid of
you money manager.

 

[NW-Bound]

Appreciate the responses thus far… so by way of an example Let’s assume then I sale all my individual stocks (which would be a $400,000 capital loss) and purchase $2,000,000 worth of VTI tomorrow. Assuming the bear market continues, could I sale all of my VTI in 3 months and purchase SCHB (or similar) and have another capital loss (assuming VTI continues to drop over those 3 months) and leverage the initial $400,000 loss plus the lost I would incur selling VTI?

If that’s the case, why doesn’t everyone perform tax lost harvesting and thus never have to pay taxes on capital gains equal to the amount of their loss? This definitely makes bear markets seem like gold mines.

No, it's not a gold mine. A loss is still a loss.

In your case, you started out with $2.4M, and will incur a loss of $400K and retain $2M. If your stash shrinks further down to $1.4M, you can add another $600K to your loss, for a total of $1M capital loss that is banked. You will not have to pay capital gain tax until you use up that $1M cap loss. But then, it means you have to get your stash to grow back past $2.4M before you pay tax again. As an investor, I would not be happy to hold a loss for that long.

I would much rather be able to grow the $2M past $2.4M ASAP, and will gladly be taxed on the gain above the original $2.4M. Paying taxes on gains is far preferable to deduct taxes for losses.

And depending on your other income, you may be able to get 0% long-term cap gain tax if you can stay in the 0% cap gain tax bracket. For a couple, the limit is $80,800, plus $25,100 standard deduction, for a total of $105,900.

This means that if your earned income is $80k, you can realize $25,900 long-term cap gain each year without paying taxes on that gain.

And if you are no longer working and live off your investments, you have no earned income and can have as much as $105,900 in qualified dividends and long-term cap gains, and pay no taxes. It does not sound fair, but that's the law.


PS. For 2022, the limit for a couple is $83,850 + $25,900 standard deduction for a total of $109,750.

 

[HarveyS]

Before getting rid of your WMC, I would recommend that you do some more reading and learning about investing. [tough love here: You asked some basic questions that someone managing a 7 figure account should know the answers to.]

You are asking specific questions on a specific piece of your investments. Why not ask your advisor, who presumably knows the whole picture - 401k, pension, real estate, etc.? The advice here is great, but only relative to the piece of the puzzle you disclosed.
What were your thoughts when you agreed to the WMC suggestions last year?

And, you need to re-evaluate your and your wife's true investment style(s).
What has changed since then? Why have you changed your mind, but DW has (apparently) not?
Obviously, the market changed. But what has changed in your psyche? Maybe you are not as aggressive as you thought? Maybe DW is more aggressive. That's OK, but be sure you understand why you want to change.

 

[Out-to-Lunch]

Appreciate the responses thus far… so by way of an example Let’s assume then I sale all my individual stocks (which would be a $400,000 capital loss) and purchase $2,000,000 worth of VTI tomorrow. Assuming the bear market continues, could I sale all of my VTI in 3 months and purchase SCHB (or similar) and have another capital loss (assuming VTI continues to drop over those 3 months) and leverage the initial $400,000 loss plus the lost I would incur selling VTI?

If that’s the case, why doesn’t everyone perform tax lost harvesting and thus never have to pay taxes on capital gains equal to the amount of their loss? This definitely makes bear markets seem like gold mines.

TLH can be conceptualized as deferring taxes. This is generally useful, but not a "gold mine."

 

[RetiredAt49]

Before getting rid of your WMC, I would recommend that you do some more reading and learning about investing. [tough love here: You asked some basic questions that someone managing a 7 figure account should know the answers to.]

I’ve spent the past year diving in investing theories/practices/etc.

The reason I wish to go out on my own is many:
1) Firm believer in the Boglehead 3 fund portfolio theory using low cost index funds
2) My WMC is an AUM and they are charging me 1.25%
3) My WMC CEO had released some content weeks/months ago suggesting that we were in just a classic correction (and was boasting about it when the market started to head back up before turning into a bear) among other things…

My comment regarding TLH = Goldmine comment was related to my ability to keep myself below the ACA limit/cliff and leverage losses to offset gains. I recognize that a loss is a loss but why not take advantage of it and put myself in a similar fund and leverage losses to offset future gains for awhile as I am only 50 years old and will be on ACA for another 15 years

 

[Montecfo]

Given you have losses, yes, loss harvesting can be very beneficial from a tax perspective, particularly if you are not a low bracket taxpayer.

 

[NW-Bound]

Given you have losses, yes, loss harvesting can be very beneficial from a tax perspective, particularly if you are not a low bracket taxpayer.

Well, with the puny $3K limit it did not help me much when I was still working.

But the 0% cap gain tax bracket helped mucho once I stopped working. The bracket was lower back then, but there were other allowed deductions such as for dependents. I washed out the cap gains by selling stocks and immediately buying them back to raise the cost basis. I lived tax-free for a few years while draining the after-tax savings and waiting to be able to tap retirement accounts at 59-1/2.

I am now paying taxes like the "common" people. Particularly as I am doing Roth conversion too. I may need to be really aggressive on the Roth conversion, as I don't have many years left till RMD.

 

[COcheesehead]

Well, with the puny $3K limit it did not help me much when I was still working.

But the 0% cap gain tax bracket helped mucho once I stopped working. The bracket was lower back then, but there were other allowed deductions such as for dependents. I washed out the cap gains by selling stocks and immediately buying them back to raise the cost basis. I lived tax-free for a few years while draining the after-tax savings and waiting to be able to tap retirement accounts at 59-1/2.

I am now paying taxes like the "common" people. Particularly as I am doing Roth conversion too. I may need to be really aggressive on the Roth conversion, as I don't have many years left till RMD.

There is no limit. The $3000 is what can be applied to reduce your regular income.

 

[NW-Bound]

There is no limit. The $3000 is what can be applied to reduce your regular income.

I know that there's no limit to offset gains.

It would be nice to completely offset other incomes.

When you have gains, the whole ball of wax is added to other incomes and taxed. But when you have a loss, it's limited.

PS. Consider this example. A guy buys a speculative stock with $100K and sold it for $1M. He has to pay taxes on the $900K gain. Now, he takes that $1M and buys another speculative stock. His luck runs out, and he finally liquidates that 2nd stock for $100K, for a loss of $900K.

Now, he can only deduct $3K each year, and the banked loss will last him 300 years.

It has happened to people who exercised stock options in the 2000 tech bubble, and got hit with taxes on very large stock gains which later evaporated.

 

[COcheesehead]

I know that there's no limit to offset gains.

It would be nice to completely offset other incomes.

When you have gains, the whole ball of wax is added to other incomes and taxed. But when you have a loss, it's limited.

PS. Consider this example. A guy buys a speculative stock with $100K and sold it for $1M. He has to pay taxes on the $900K gain. Now, he takes that $1M and buys another speculative stock. His luck runs out, and he finally liquidates that 2nd stock for $100K, for a loss of $900K.

Now, he can only deduct $3K each year, and the banked loss will last him 300 years.

It has happened to people who exercised stock options in the 2000 tech bubble, and got hit with taxes on very large stock gains which later evaporated.

I had a bunch of tax losses from 2008. I milked them all the way into 2016. With RE the way it is, some will likely even be able to use them for RE gains above the exemption. Most folks can use tax loss harvests since capital gains are almost a way of life.

 

[ownyourfuture]

It has happened to people who exercised stock options in the 2000 tech bubble, and got hit with taxes on very large stock gains which later evaporated.

I had forgotten about that.
https://www.latimes.com/archives/la-xpm-2000-dec-22-fi-3328-story.html

 

[Texas Proud]

Others have said about the first two questions.... but the third I have a comment...


You CAN tax loss harvest IF you have your brokerage keep track of the purchases and you specify what you are selling..


However, it seems like you are going to put 100% of your cash into funds so the basis will be the same.... you cannot really 'harvest' if the cost basis is the same...

 

[COcheesehead]

Others have said about the first two questions.... but the third I have a comment...


You CAN tax loss harvest IF you have your brokerage keep track of the purchases and you specify what you are selling..


However, it seems like you are going to put 100% of your cash into funds so the basis will be the same.... you cannot really 'harvest' if the cost basis is the same...

Unless the position is down.

 

[Graybeard]

If I am wrong please someone correct me, I hope I am wrong!

From what I understand, when taking the annual $3k loss against income you benefit only by the tax bracket you are in. For example, in the 22% bracket then you lower your taxable income by $3k * 22% which is just $660.

I think cap gains can offset cap losses dollar for dollar.

Please correct me if I'm wrong on those.

 

[NW-Bound]

If I am wrong please someone correct me, I hope I am wrong!

From what I understand, when taking the annual $3k loss against income you benefit only by the tax bracket you are in. For example, in the 22% bracket then you lower your taxable income by $3k * 22% which is just $660.

I think cap gains can offset cap losses dollar for dollar.

Please correct me if I'm wrong on those.

No, it reduces your taxable income by $3K, which means $660 reduction in taxes.

A $1 cap loss results in 22c tax reduction, if you are in the 22% bracket.

A $1 in cap gain also results in 22c tax increase. Or the tax can even be 0, if it is long-term cap gain and you are the right bracket, as I described earlier.

 

[NW-Bound]

I had forgotten about that.
https://www.latimes.com/archives/la-xpm-2000-dec-22-fi-3328-story.html

That LA Times archive article from 2000 is behind a paywall.

Recently, I dug up a similar story in an archived Chicago Tribune article from April 2001.

See: https://www.chicagotribune.com/sns-tech-taxes-story.html.

The gist: A tax bill of $2.5M is due on a cap gain of $6.9 million, but the stock collapsed and was worth only $1.8M. After selling his stock to pay taxes, the lucky-turned-unlucky guy still had to come up with $700K out of pocket to pay taxes.

And selling a stock used to be worth more than $6.9M for $1.8M means he now had a capital loss of $5.1M to carry forward. If he was lucky again to strike another multi-million option, he could use the $5.1M loss to offset future gains. Else, he could write off $3K each year for the next 1,700 years.

Many of these workers now owe far more in taxes than their stock is worth. Former Cisco engineer Jeffrey Chou, 32, owes $2.5 million in taxes on company stock he purchased last year that has since withered in value. Chou figures that if he were to sell everything he owns, including the three-bedroom Foster City, Calif., townhouse that he shares with his wife and 8-month-old daughter, the family still could not pay the bill.

Chou used incentive stock options to buy about 100,000 Cisco shares last year, paying 5 to 10 cents for each share. At the time, Cisco stock was trading between $60 and $70 a share. The difference between the price he paid and what the shares were worth -- about $6.9 million -- is taxable to him as profit, even though he never sold the shares.

Under the AMT, the first $175,000 of Chou's taxable income is taxed at a federal 26% rate, and any amount over that is taxed at 28%. Add in state taxes, and the bill is $2.5 million.

Chou could sell his shares now, but it wouldn't solve his problem. Cisco closed Thursday at $17.98 a share, which means that his stake is worth about $1.8 million.

 

[Graybeard]

No, it reduces your taxable income by $3K, which means $660 reduction in taxes.

A $1 cap loss results in 22c tax reduction, if you are in the 22% bracket.

A $1 in cap gain also results in 22c tax increase. Or the tax can even be 0, if it is long-term cap gain and you are the right bracket, as I described earlier.

Thanks but didn't I say that? I said you only get a $660 reduction.

From what I understand, when taking the annual $3k loss against income you benefit only by the tax bracket you are in. For example, in the 22% bracket then you lower your taxable income by $3k * 22% which is just $660.

How about cap gains/cap losses, are they dollar for dollar or also subject to the tax bracket?

 

[NW-Bound]

Thanks but didn't I say that? I said you only get a $660 reduction.

How about cap gains/cap losses, are they dollar for dollar or also subject to the tax bracket?

OK, I misread what you wrote.

I don't understand your question, so here's an example.

You had a capital loss of $10K in 2021. You can take $3K off your earned income, and save $660 in fed tax if you are in the 22% bracket. You retain $7K of losses for future years.

In 2022, let's say you have a cap gain of $9K. Applying the $7K loss carryover, you have a net gain of only $2K that is now taxable.

How much tax to pay on that $2K depends on your bracket, and all that.

 

[Texas Proud]

Unless the position is down.

Harvesting to me means that you are selling your losers and keeping your winners....


If every share has the same price you either have all as a gain or all as a lost... no decision to be made as you cannot 'harvest' a specific lot...

 

[copyright1997reloaded]

Well, with the puny $3K limit it did not help me much when I was still working.

But the 0% cap gain tax bracket helped mucho once I stopped working. The bracket was lower back then, but there were other allowed deductions such as for dependents. I washed out the cap gains by selling stocks and immediately buying them back to raise the cost basis. I lived tax-free for a few years while draining the after-tax savings and waiting to be able to tap retirement accounts at 59-1/2.

I am now paying taxes like the "common" people. Particularly as I am doing Roth conversion too. I may need to be really aggressive on the Roth conversion, as I don't have many years left till RMD.

This.

I have been doing the same strategy for my child (now 20) - tax gain harvesting - to the (low) limit for a return for a child with no earned income.

Now that he is working (this year), I will lose him in terms of head of household, but he will be able to pay long term capital gains at the 0% rate - so it makes sense for me to transfer appreciated stock to him (i.e. gift) and then sell it vs. me selling things and gifting him cash.

I have also "enforced" an investment plan on him where 1/3 of his net pay is going to a Roth IRA (and I gift him the same $ amount to his savings account).