Capital gains or Roth conversion in 2012?

[pb4uski]

I early retired in late 2011 and have been living from taxable accounts in 2012. If I do nothing, my taxes for 2012 would be ZERO based on my income which is a little bit of vacation pay received in 2012, interest, dividends and capital gains less HSA contributions less itemized deductions for medical insurance, property taxes and contributions.

Option 1 is to do $x of Roth conversions which will result in taxes which are about 7% of the Roth conversion amount.

Option 2 is to make some sales and repurchases in my taxable account which result in $x of capital gains (wash sale doesn't apply to gains) and still pay ZERO in taxes, which would have the effect of increasing the basis of my taxable account holdings so when I use my taxable account for living expenses in later years my capital gains will be lower (and I could do the Roth conversions later).

I'm trying to think through the pros and cons of each alternative. I would probably lean to Option 1 since 7% tax cost seems pretty attractive especially when the earnings on the proceeds will become tax-free. I could easily do a mix of both.

Anything else I should consider?

[grasshopper]

State taxes on LTCG?

[pb4uski]

Yes, both Roth conversions or capital gains would be included in income and taxed at the same rate for state tax purposes, so state taxes are not relevant to the decision between Option 1 or Option 2.

(But would be relevant between doing nothing and Options 1 or 2).

[GrayHare]

Only reason I can think of to favor the Roth conversion is if you expect your tax rate to be higher when you do future withdrawals. If your future ordinary income tax rate is uncertain, then I'd favor "washing" Cap Gains now since their tax rate seems more likely to increase in the future, perhaps as soon as next year.

[grasshopper]

I am taking LTCG to the 15% top level. Since I also know that I will have a big distribution in one of my MF in December. So if I take it now the gain will be LTCG and not a dividend which could bump my income up. I will be recharacterizing a ROTH conversion I did early this year, I am starting to think RMD's before Ms G has to start taking them will be minimal.

[RE2Boys]

Quote:

Originally Posted by pb4uski Yes, both Roth conversions or capital gains would be included in income and taxed at the same rate for state tax purposes, so it state taxes are not relevant to the decision between Option 1 or Option 2. (But would be relevant between doing nothing and Options 1 or 2).

May be true in most, but not all states. Here in PA, the Roth conversion is a non-taxable event while the cap gains are taxable.

[pb4uski]

Quote:

Originally Posted by RE2Boys May be true in most, but not all states. Here in PA, the Roth conversion is a non-taxable event while the cap gains are taxable.

Understood, I was referring to my specific situation.

[kaneohe]

Quote:

Originally Posted by grasshopper I am taking LTCG to the 15% top level. Since I also know that I will have a big distribution in one of my MF in December. So if I take it now the gain will be LTCG and not a dividend which could bump my income up. .

Would the dividend be a qualified dividend? If so, wouldn't the effect of having it as QDIV be the same as if it were LTCG in the 15% bracket
(= 0)?

[kaneohe]

No capital loss carryforwards? Will you actually be selling from taxable account eventually or might it benefit heirs w/ stepup in basis? What are you assuming re: tax rates this yr vs future? If LTCG rate goes from 0/15% to 10/20 in the 15/>15% brackets, then in the 15% bracket, you pay 10% less by selling this yr. If your income stays the same and the 15% tax bracket doesn't change, then you lose nothing by delaying the Roth conversion. Even if the 15% bracket were to increase, it seems unlikely to increase to 25% (10% more which would balance the 10% less you pay for taking the CG now). ......... so another vote w/ GrayHare for CG assuming the other factors are not playing a role

[grasshopper]

Quote:

Originally Posted by kaneohe Would the dividend be a qualified dividend? If so, wouldn't the effect of having it as QDIV be the same as if it were LTCG in the 15% bracket (= 0)?

Last year the distribution was 1/3 qualified, 2/3 ordinary.

[pb4uski]

Quote:

Originally Posted by kaneohe No capital loss carryforwards? Will you actually be selling from taxable account eventually or might it benefit heirs w/ stepup in basis? What are you assuming re: tax rates this yr vs future? If LTCG rate goes from 0/15% to 10/20 in the 15/>15% brackets, then in the 15% bracket, you pay 10% less by selling this yr. If your income stays the same and the 15% tax bracket doesn't change, then you lose nothing by delaying the Roth conversion. Even if the 15% bracket were to increase, it seems unlikely to increase to 25% (10% more which would balance the 10% less you pay for taking the CG now). ......... so another vote w/ GrayHare for CG assuming the other factors are not playing a role

No capital loss carryforwards (offset by gains I have already taken this year and are baked into the $0 taxes in the do nothing scenario).

I'm warming up to the CG alternative given that it seems likely that CG tax rates will increase for 15% tax bracket people but ordinary rates will not so it may be best to get the stepped up basis while it is available.

Besides, I can brag at cocktail parties that I had $y income and paid no income taxes and people will think I'm a genius (or a tax cheater).

[pb4uski]

Quote:

Originally Posted by GrayHare Only reason I can think of to favor the Roth conversion is if you expect your tax rate to be higher when you do future withdrawals. If your future ordinary income tax rate is uncertain, then I'd favor "washing" Cap Gains now since their tax rate seems more likely to increase in the future, perhaps as soon as next year.

The future tax rate is a good point I need to think about. If I forgo the Roth conversion opportunity now, my RMDs would be incrementally higher. The higher RMDs, combined with my SS and pensions would probably put us in the 25% bracket. I don't have enough time between now and 70 1/2 to convert all IRA money to Roths.

So if I do the Roth conversion, I pay ~7% tax rate and avoid paying ~25% in ~13+ years so the net benefit is 18%. If I do the CG, I pay 0% now and avoid paying whatever the CG tax rate is later (say 15-20% for discussion purposes) the net benefit is 15-20% so it looks like a push depending on what my crystal ball things future CG tax rates will be.

Perhaps I'll split the baby in that I could fully convert DW's IRA and have one less investment account to deal with which would be about half of the amount and then I can do CG for the remainder.

[clifp]

I'd vote for the capital gains given the huge uncertainty regarding capital gains. I believe there is a chance that nothing will be done to avert the fiscal cliff, and only a slight chance that anything will be done by the end of the year.