How to deal with taxable holdings with large gains

[disneysteve]

When we started investing 3+ decades ago, I was mainly focused on acquisition and growth and gave little to no thought to future tax implications when it came time to sell. Now here we are with a very nice portfolio but some of our holdings have substantial unrealized capital gains and it's time to start tapping those taxable holdings to help support our spending.

How do I best approach starting to sell off some of those holdings? For example, we own one fund that is worth about 198K of which around 90K is gains if we were to sell it all today.

Do I just start selling it off gradually to not take too big a tax hit in any one year? I could sell like 10K worth of shares each year and have about 4.5K in LTCG as a result. That wouldn't be enough extra income to have any significant impact on things overall (ACA subsidy, etc.). I would set aside 15% of the gain for taxes and use the rest for spending. Does that make sense or is there is a better way to go about it? Yes it would all be LTCG in this example.

 

[RunningBum]

Unless your taxable income is low enough to have 0% tax on some LTCGs, or in the future will be high enough to have IRMAA issues, NIIT, 20% cap gains, etc, I would just sell what you need to each year. The main reason is if it turns out you didn't need the money for your own spending, you could've passed it on to heirs with a stepped up basis, or donate to charity without incurring a tax. This assumes the fund does not overweight your asset allocation to the point you would want to rebalance. If it were a single stock that is a significant % of your holdings I would probably be more aggressive with selling.

 

[disneysteve]

Unless your taxable income is low enough to have 0% tax on some LTCGs, or in the future will be high enough to have IRMAA issues, NIIT, 20% cap gains, etc, I would just sell what you need to each year. The main reason is if it turns out you didn't need the money for your own spending, you could've passed it on to heirs with a stepped up basis, or donate to charity without incurring a tax. This assumes the fund does not overweight your asset allocation to the point you would want to rebalance. If it were a single stock that is a significant % of your holdings I would probably be more aggressive with selling.

Thanks for the input.

I'd love to be able to avoid some tax by donating shares but that would require itemizing deductions which doesn't make sense for us thanks to the higher standard deduction now. We've done that in the past before they changed things.

Allocation wouldn't be an issue and if necessary I can always rebalance using holdings in IRAs/Roths so there'd be no tax impact.

 

[RE2Boys]

Thanks for the input.

I'd love to be able to avoid some tax by donating shares but that would require itemizing deductions which doesn't make sense for us thanks to the higher standard deduction now. We've done that in the past before they changed things.
.

There is a chance that the standard deductions will be cut in half when the Trump tax cut expires in 2026

 

[disneysteve]

There is a chance that the standard deductions will be cut in half when the Trump tax cut expires in 2026

If that happens we might go back to itemizing, though it would depend on medical bills most likely since we have no mortgage.

 

[RunningBum]

I made a large donation of appreciated stock to a DAF in one year, lumped with anything else I could deduct the last year of the lower standard deduction. Now I do grants from my DAF so that my preferred charities still get their yearly amount from me, but I'm not actually donating anything more from my own funds--it all comes from that one bulk donation. If you choose to do this just watch for the limit on what % of income you can donate as stock funds.

 

[TheWizard]

Your more recently purchased lots will have smaller capital gains so sell those first.
Retain the lots purchased 30 years ago for stepped up basis to your heirs once you pass...

 

[SecondCor521]

Two reasonable approaches would be: (1) Sell shares with smallest LTCG to get the most "spending for taxes incurred" (As TheWizard mentions above) and (2) Sell shares of the investment you like the least. Or a blend of the two approaches.

Selling gradually generally will make sense. There may be scenarios where you may want to "capital gain harvest" by selling more than you need in order to fill up the 0% LTCG bracket or up to 400% FPL for ACA or some other AGI target. The idea would be turn around and repurchase the shares (or something different - doesn't matter because wash sale rule doesn't apply when gains are incurred), hoping to pay 0% or 15% now to avoid 15% or 20% later.

Also, you probably want to consider whether using your taxable account to fund spending is the best choice. Other choices might be taking SS or a pension, or using traditional IRA or Roth IRA funds. Personally I fund all my living expenses from taxable right now, but in other situations I might choose one of the other options.

 

[TheWizard]

Part of the answer depends on your situation.
I started RMDs a few years ago so I'm putting even more into my taxable account each month, though occasionally I might do a big withdrawal to buy a new vehicle.

Other folks may need to withdraw from taxable on a regular basis...

 

[FlaGator]

Two reasonable approaches would be: (1) Sell shares with smallest LTCG to get the most "spending for taxes incurred" (As TheWizard mentions above) and (2) Sell shares of the investment you like the least. Or a blend of the two approaches.

Selling gradually generally will make sense. There may be scenarios where you may want to "capital gain harvest" by selling more than you need in order to fill up the 0% LTCG bracket or up to 400% FPL for ACA or some other AGI target. The idea would be turn around and repurchase the shares (or something different - doesn't matter because wash sale rule doesn't apply when gains are incurred), hoping to pay 0% or 15% now to avoid 15% or 20% later.

Also, you probably want to consider whether using your taxable account to fund spending is the best choice. Other choices might be taking SS or a pension, or using traditional IRA or Roth IRA funds. Personally I fund all my living expenses from taxable right now, but in other situations I might choose one of the other options.

Good info here, at least it describes what I've done.

I worked down my taxable account over the first 7 years, taking advantage of selling specific lots to minimize gains while doing some conversions. What's now left is 2008-12 shares that got a partial step up in basis after the wife passed. Gains are almost 2/3 of the total, so will do my best to hold them as-is and pass to my kids.

Started to drawn down my IRA for 2023-24 expenses, and with no spouse, will likely start SS in the next 12 months.

 

[Closet_Gamer]

I made a large donation of appreciated stock to a DAF in one year, lumped with anything else I could deduct the last year of the lower standard deduction. Now I do grants from my DAF so that my preferred charities still get their yearly amount from me, but I'm not actually donating anything more from my own funds--it all comes from that one bulk donation. If you choose to do this just watch for the limit on what % of income you can donate as stock funds.

This is a great strategy.

We alternated years where we would donate a big chunk to a DAF with years where we take the standard deduction. Over time we built up what I thought of as my “Charity 401k”. The “match” was the avoided cap gains taxes.

As I head into FIRE, we now have a nice sum in the DAF. We will donate 3.5% per year + inflation. I expect it to become a perpetual donation engine for the rest of our lives. The ultimate charity donations will way outstrip what we put into it.

 

[Texas Proud]

Is it a single company or fund? I have huge gains in many of my investments...



Right now I am selling off the funds in the ROTH and using that for expenses...


However, I do have a big slug of my mega company stock and am going to start to sell some each year... but to juice up my gain I am going to sell options... if they hit I am getting the price I want on the stock plus the premium... if they do not I get to sell options again!!

 

[jim584672]

If you don't need the money leave it to heirs and they will get a stepped up basis at death.

 

[disneysteve]

If you don't need the money leave it to heirs and they will get a stepped up basis at death.

That raises a whole different question. Is it better to spend down taxable assets first or tax-free assets? We have Roth, traditional IRAs, a 401k, and taxable investments. We need to get money from somewhere in retirement. I don’t want to derail this thread but I know there are plenty of others discussing order of withdrawal strategies.

 

[SecondCor521]

That raises a whole different question. Is it better to spend down taxable assets first or tax-free assets? We have Roth, traditional IRAs, a 401k, and taxable investments. We need to get money from somewhere in retirement. I don’t want to derail this thread but I know there are plenty of others discussing order of withdrawal strategies.

It's a complex question and the answer is probably "It depends" because there are pros and cons to each option.

Selling taxable usually means you get more spendable dollars per dollar of tax incurred (because part of the sale is basis). But you lose step up.

Selling tax deferred means (usually) more taxes per spendable dollar, but you may be doing your heirs a favor if their brackets are higher. But you lose the future tax-deferred compounding over the remainder of your life and their (probably) 10-year SECURE period.

The answer for any individual probably depends on:

1. Ratio of basis vs. gains (or losses) in taxable.
2. Life expectancy.
3. MFJ or single.
4. Tax situation.
5. Other income (SS / pensions).
6. How much of necessary / actual spending is covered with "forced" income.
7. Number of heirs / heirs tax situations / legacy preferences.
8. AA / risk tolerance.
9. Relative ratios of taxable / tax-deferred / tax-free.
10. Opinion of future potential changes to tax law and SS.

And there could be more factors I'm not thinking of offhand.

 

[Out-to-Lunch]

That raises a whole different question. Is it better to spend down taxable assets first or tax-free assets? We have Roth, traditional IRAs, a 401k, and taxable investments. We need to get money from somewhere in retirement. I don’t want to derail this thread but I know there are plenty of others discussing order of withdrawal strategies.

As SecondCor says, it depends. Here is a good overview from Kitces: https://www.kitces.com/blog/tax-efficient-retirement-withdrawal-strategies-to-fund-retirement-spending-needs/

 

[Wetfly93]

Right now I am selling off the funds in the ROTH and using that for expenses...

Texas wrote this and I wonder why you would sell out Roth money for expenses? My Roth account would be the last money I would touch allowing g it to grow tax free. Would like to understand why this would be done.

 

[SecondCor521]

Texas wrote this and I wonder why you would sell out Roth money for expenses? My Roth account would be the last money I would touch allowing g it to grow tax free. Would like to understand why this would be done.

The typical reason I see mentioned here is when one wants to make a large purchase and doesn't want to increase their tax bill or take a loan. Like a new Lamborghini or something.

I think the Kitces article above (post #16), if it's the one I think it is, also talks about withdrawing from multiple sources in a blended way each year to optimize things. That could involve drawing from Roth a bit each year rather than the approach you're implying of drawing fully from one account until drained, then repeating that with all accounts in serial fashion.

 

[Midpack]

If you don't need the money leave it to heirs and they will get a stepped up basis at death.

+1. That's been my plan, haven't sold anything yet, and don't foresee ever having to.

 

[RunningBum]

Another reason I'll tap the Roth before taxable is that my heirs will get a stepped up basis on taxable assets. I'll spend small gainers in taxable, but I've got a couple of index funds that have about tripled in value. If I don't ever sell them, they grow tax free as effectively as a Roth does, so this way nobody pays taxes on them. If I do need them later in life, it's likely because I have large medical expenses so I can sell some of the index funds and write off medical expenses for much of the gains.

 

[Texas Proud]

Texas wrote this and I wonder why you would sell out Roth money for expenses? My Roth account would be the last money I would touch allowing g it to grow tax free. Would like to understand why this would be done.

I almost missed this since you did not quote me correctly where I saw my name...


I have been keeping taxable income low for ACA credits... At first there were 4 on the policy... then 3 and now 2 as I am on medicare..


Anything taken from a regular IRA reduces my credit and can kick me into not getting the good silver plan... not that I got it all the time anyhow...


BTW, I used up all my cash in my taxable account first, then sold stuff with not much in cap gains before I started using the ROTH...

 

[urn2bfree]

Another option no one has yet mentioned in investing the gain in a QOZ fund. That defers the taxes and if you hold it long enough I believe you can avoid the taxes on capital gains on the investment. Example- QOZ Fund III

 

[LateToFIRE]

This thread is of special interest for me, as recently FIRE'd, but yet to develop a draw-down strategy. Not urgent, as I set aside two years of spending in cash - I know not very efficient but lets me sleep better. But, want to have a plan in place as future pension/SS will help but not fully cover our expenses.

Our assets include some of everything (Taxable, T/IRA (pre-tax), T/IRA(after-tax), Roth/IRA, Inherited/IRA, Investment R.E. and so on). My goal is simplification and tax minimization. Thinking is as follows:

1) Spend down existing cash balance first.
2) Sell off excess real estate - will generate a very sizable cash influx, but also incur huge capital gains tax.
3) Invest proceeds from r.e., use these newer taxable funds first given low tax basis.
4) Stretch Inherited IRA RMD's as long as possible to reduce taxable income
5) Execute Roth conversions during period of lower taxable income (before pension/SS kick in)
6) Preserve Roth IRA's for as long as possible
7) Eventually T/IRA RMD's will kick us into a high tax bracket, but hopefully the conversions will dampen impact.

If all goes as projected, our portfolio should continue to grow materially over our lifespans - i.e. growth should exceed withdrawals unless we incur some really nasty SORR early on, fail to reduce expenses as much as anticipated, or make some really bad investment decisions. Basically, plan to spend down Taxable first, then RMD's force pro-rata WD's from T/IRA'S. The Roth's are not expected to be needed and would be left to grow substantially over time.

Thoughts welcome.

 

[LateToFIRE]

Another option no one has yet mentioned in investing the gain in a QOZ fund. That defers the taxes and if you hold it long enough I believe you can avoid the taxes on capital gains on the investment. Example- QOZ Fund III

Thanks! Very relevant for me as will be incurring cap gains headache from r.e. sales.

 

[LateToFIRE]

This thread is of special interest for me, as recently FIRE'd, but yet to develop a draw-down strategy. Not urgent, as I set aside two years of spending in cash - I know not very efficient but lets me sleep better. But, want to have a plan in place as future pension/SS will help but not fully cover our expenses.

Our assets include some of everything (Taxable, T/IRA (pre-tax), T/IRA(after-tax), Roth/IRA, Inherited/IRA, Investment R.E. and so on). My goal is simplification and tax minimization. Thinking is as follows:

1) Spend down existing cash balance first.
2) Sell off excess real estate - will generate a very sizable cash influx, but also incur huge capital gains tax.
3) Invest proceeds from r.e., use these newer taxable funds first given low tax basis.
4) Stretch Inherited IRA RMD's as long as possible to reduce taxable income
5) Execute Roth conversions during period of lower taxable income (before pension/SS kick in)
6) Preserve Roth IRA's for as long as possible
7) Eventually T/IRA RMD's will kick us into a high tax bracket, but hopefully the conversions will dampen impact.

If all goes as projected, our portfolio should continue to grow materially over our lifespans - i.e. growth should exceed withdrawals unless we incur some really nasty SORR early on, fail to reduce expenses as much as anticipated, or make some really bad investment decisions. Basically, plan to spend down Taxable first, then RMD's force pro-rata WD's from T/IRA'S. The Roth's are not expected to be needed and would be left to grow substantially over time.

Thoughts welcome.

Just amending something I said above. Went back and looked at my model. Not looking to start a Roth conversion debate, lol. But, noting for my specific situation that I project to be living in a 22%-plus marginal tax bracket for the rest of my life - not the worst thing that could happen. Most scenarios I run have conversions hurting rather than helping. The other reason they hurt in my model is because we don't ever tap the Roth funds - perhaps I should think in terms of mixing in some Roth WD's rather than only using Taxable.

This is the problem with using static models to review multi-dimensional issues. There are some circumstances in which the conversions might help. For example, one of us dies early pushing the survivor into an even higher bracket, or Fed/State rates go up significantly in the future. Bottomline, for us, conversions will be about hedging future tax increases, rather than any assured benefit. If I had to guess, I'd bet that after a year or two of conversions, I'll get so PO'd about writing checks to the IRS, I'll quit doing them. FYI, no concerns about heirs and taxes - they'll just have to suck it up and be happy with what they get however they get it.