SMH - huge surprise capital gains in taxable

[jblack]

I can't believe I did this. I am typically uber-careful and plan all my portfolio activities with a ton of spreadsheets and deliberate consideration of all the angles. Have been doing this successfully for 20+ years and have learned a ton from the collective wisdom here. We are nearing the end of our accumulation mode and have for years been fortunate enough to max out pre-tax contributions, do mega backdoor Roths, 529s, and taxable investments. All good.

Well this past August I was doing some very infrequent re-balancing (once every couple of years) and accidentally did it in our taxable Vanguard account. I KNOW that "exchanging" one equity index fund (S&P 500, VTSAX) for another one (International, VTIAX) means selling one and buying the other but perhaps because I've always had room in our 401ks or Roths to rebalance or it's been so long since I've done anything in the taxable account except deposit funds automatically that I had this lapse in judgement. And it was a big one to the tune of ~$500k.

Fast forward to this morning when I'm starting to import 1099s into TurboTax. Everything is looking as expected....W2s, 1099-DIVs, and then BOOM the tax bomb goes off to the tune of $92k extra due with the 1099-B from Vanguard. I was floored and so upset with myself once I realized how it occurred. It was nearly all long-term gains of course but I really didn't have an immediate need to take it and because our income has been fortunately been high it's at the 20% CG + 3.8% net investment income tax. Argh!

I think I'm mostly venting here. I mean I could have put it into some crazy risky investment and done worse. And eventually the tax will have to be paid anyway, but I'm so frustrated by the inefficiency I've caused on a smaller portion of our overall investments. And now I need to go sell part of the new position because of course I didn't withhold anything for taxes.

Am I making too big a deal out of this and/or is there any other strong upside / opportunity I should now consider with the higher basis on the new investment?

Thoughts and advice welcome. Thanks!!!

 

[gamboolman]

jblack

I just did basically the same thing last week. Swapped from Mutual Funds to ETF's for ~$550K - so very similar to your amount.

Here's a picture ms gamboolgal took of me just after I realized I had whopped up:

 

[COcheesehead]

I keep close tabs on taxes. Not sure if Vanguard has it, but Fidelity has year to date tax info for taxable accounts so you always know where you stand. I also run proforma 1040’s on Dinkytown so I have a pretty good idea on taxes throughout the year. It helps me to send in estimated taxes or do tax loss harvesting to offset gains.

If the gains were incurred earlier in the year, you might get hit with a penalty too if you didn’t send in estimated taxes.

 

[DawgMan]

First world problems... better than a sharp stick in the eye!

I really try to minimize rebalancing in my after tax accounts that create capital gains for the very reason you noted. I am recently "retired" and expect to take my first withdrawal this year. My ETFs/MFs naturally create dividends/CGs/interest on their own each year that will cover almost 2/3rds of my planned FAT FIRE spend. My next exercise is Roth conversions for the next 15 years and all the joys of calculating my annual taxes!

Just remind yourself you are lucky to pay all those taxes! None the less, feel your pain.

 

[jblack]

Wow, thanks for the quick responses already.

gamboolman - ha, that is pretty much what my wife wanted to do to me when I showed her the updated taxes due. On the plus side, though, we have been considering a vacation home that would likely require us to sell some equities anyway so I tried to sell her on the glass half full view that it's that much easier now

COcheesehead - good point on the potential underpayment penalty. The unplanned gains were recognized in mid-August but most of our taxes are paid throughout the year in normal paychecks and Spring bonuses. We should be in the safe harbor with more taxes already paid (extra W4 payments) than the prior year, but I won't feel good until I actually see it at the end of all the tax prep.

DawgMan - your approach is exactly our plan as well for funding our ER. Hopefully soon if OMY syndrome doesn't delay us too much!

 

[MichaelB]

Am I making too big a deal out of this and/or is there any other strong upside / opportunity I should now consider with the higher basis on the new investment?

Thoughts and advice welcome. Thanks!!!

As a renowned forum member reminds us, “numbers is hard”. Look at the bright side. You didn’t make a stupid investment or lose the money. It’s still painful, but your money is still there, and what you’ve really done is give Uncle his share ahead of time.

Don’t beat yourself up over this, there are much worse money mistakes. Pay the tax and put it behind you.

 

[Magus]

Ugh - sounds like something I will do in my retirement for certain. On the bright side, it'll be easier to move $ around for a bit if you choose to do so, especially with the market down you can maybe generate some tax loss for the next few years given the pullback...

 

[Chuckanut]

File this under misery loves company.

Interesting article in today's WSJ about how Vanguard distributed some huge capital gains in their Target Date funds. It seems that if the TD funds were not in a tax sheltered account, well.... you can guess what happened. Check Jason Zwieg's column of 1/21/2022.

https://www.wsj.com/articles/vanguard-target-retirement-tax-bill-surprise-11642781228

These funds are tailored for investors in 401(k)s or other retirement plans where taxes are deferred. So target funds aren’t managed to minimize dividends or capital gains. Hold them in a taxable account instead of a retirement plan, and you will owe taxes on those payouts—sometimes much more than you would in other types of funds.

In the Bogleheads area on Reddit, another online forum, an investor posting as “Sitting-Hawk” said he received about $550,000 in distributions in Vanguard’s Target Retirement 2035 fund. So he owes 23.8% in federal tax and 4.95% in Illinois state tax—all told, more than $150,000.

 

[SecondCor521]

Like you, I try very hard to optimize my taxes. In general I think I do a pretty good job, but occasionally I make mistakes. Because of my personality, this is a hard pill to swallow.

In the grand scheme of things, given the amount of money you're talking about, 23.8% is actually probably a pretty good rate to have paid. I doubt you'll pay much less than that on average when you hit your RMD ages. And if you were going to sell it to spend on something anyway, it's not that big of a deal really given that the cash would have made nothing and the investments could have moved against you between when you did sell and when you would have sold.

The only scenario where it seems like a moderate error is where you would have and could have held that $500K in that taxable investment until death and then your heirs would have avoided the 23.8% via basis step up (assuming that's still around then). But then in that case, you've lived (presumably well) off other money, and your heirs are probably still getting a moderate to large inheritance.

You're still probably doing far better than most and making far fewer mistakes than most. I'm pretty sure I am.

 

[disneysteve]

I feel your pain. I didn't do anything intentional to generate a big tax bill but two of our taxable MFs paid out large CGs for 2021 to the tune of over 40K between them. I had to send off a 4th quarter tax estimate payment of over 9K and will likely owe another thousand or so at tax time.

 

[CaliKid]

... and then BOOM the tax bomb goes off to the tune of $92k extra due with the 1099-B from Vanguard.

I think I'm mostly venting here.

...

Thoughts and advice welcome. Thanks!!!

Venting and maybe a little flexing, no!? $92k extra due is a pretty large gain. Almost large enough that I'd keep the dollar amount to myself if I were ever in such a position.

Good problems to have! We should all have such problems!

 

[audreyh1]

jblack

I just did basically the same thing last week. Swapped from Mutual Funds to ETF's for ~$550K - so very similar to your amount.

If you switched from a mutual fund to the same ETF, I don’t think that’s a taxable event. Check with Vanguard.

 

[jblack]

Venting and maybe a little flexing, no!? $92k extra due is a pretty large gain. Almost large enough that I'd keep the dollar amount to myself if I were ever in such a position.

No, not intending to flex at all. I agree 100% this is a first world problem and I acknowledge I'm quite fortunate to be in this position. I come from a very middle class background in one of the lowest 2-3 economic states (yes, which is still in the US), have worked as smart and hard as I can for many years and do try to stay humble. And again these are gains that mostly came from 20+ years of investment & compounding in boring index funds.

I debated putting the actual #s but thought it made it more impactful and real. Apologies if this comes across to anyone as bragging. Next time I will only use a % or omit such details.

Thanks for all the other responses as well! I will simply take my medicine and be wiser in the future.

 

[COcheesehead]

Not sure I’d call it flexing when these gains could have been rolled off at a lower rate over time and without the 3.8% kicker. Its not what you earn, it’s what you keep.

 

[gamboolman]

If you switched from a mutual fund to the same ETF, I don’t think that’s a taxable event. Check with Vanguard.

Thank you Audreyh1,

Messages have been sent to VG and our CPA.

I'll try to post back the more accurate determination from the experts and estimate of my mistake so that others can learn.

If there is not one already - we might ought to start a "I Messed Up" Thread.....
Who know's - I may dubiously be in the lead for 2022 worst / costliest error...

 

[Exchme]

If you switched from a mutual fund to the same ETF, I don’t think that’s a taxable event. Check with Vanguard.

Correct, at least at Vanguard, if you just have them put you in the ETF equivalent, it's not taxable, the shares were never sold, just switched the ownership type. They told me they couldn't do that with the Total Bond Market Mutual Fund, that had to be sold to switch to the ETF. I said to just forget about that one, I intend to spend those bonds down soon anyway.

 

[FLSUnFIRE]

If one wanted to flex, they'd go elsewhere, I don't think anyone here is trying to impress anyone else here... if so, they are in the wrong place. $92K is 2+ years expenses to me and I'm not impressed and don't think my modest portfolio impresses anyone else even though most in the overall population would consider me "rich"... until find out I live off about $40K and most of that is taxes and insurance. I'm just "rich" enough to live "poor."

 

[disneysteve]

I debated putting the actual #s but thought it made it more impactful and real.

I see absolutely nothing wrong with posting real numbers if you are comfortable doing so. We do that here all the time.


This post wouldn't have been nearly as meaningful without the numbers.

 

[Souschef]

I have little control over my taxes. Our SS and pensions are fixed, and the biggest ordinary income comes from our RMD's. I am using QCD's to cut that down, however.

They totally overshadow and dividends or capital gains.
First world problem.

 

[Sunset]

I feel your pain. I didn't do anything intentional to generate a big tax bill but two of our taxable MFs paid out large CGs for 2021 to the tune of over 40K between them. I had to send off a 4th quarter tax estimate payment of over 9K and will likely owe another thousand or so at tax time.

We detest MF's in regular accounts. I would complain about them yearly, but DW didn't mind as I do the tax return.

Then one year, I'm out of the country and she gets her tax statement from a MF, and in it she has $70K CG. She phoned me in shock

Now she agrees, no more MF in taxable accounts, and we are working on converting to all ETF's over the years.

That $70K CG was not normal, but I even hated the $5K ones as I can't plan and have no control over them.

 

[target2019]

No, not intending to flex at all. I agree 100% this is a first world problem and I acknowledge I'm quite fortunate to be in this position. I come from a very middle class background in one of the lowest 2-3 economic states (yes, which is still in the US), have worked as smart and hard as I can for many years and do try to stay humble. And again these are gains that mostly came from 20+ years of investment & compounding in boring index funds.

I debated putting the actual #s but thought it made it more impactful and real. Apologies if this comes across to anyone as bragging. Next time I will only use a % or omit such details.

Thanks for all the other responses as well! I will simply take my medicine and be wiser in the future.

As time goes on it becomes easier to make mistakes. Posting a real number in isolation like that isn't a problem.

If you'll pay $9,000 extra in taxes, I would say the school of hard knocks owes you a few credits for the course.

 

[DawgMan]

Correct, at least at Vanguard, if you just have them put you in the ETF equivalent, it's not taxable, the shares were never sold, just switched the ownership type.

That's interesting. I get they may be equivalent, but the fact they are separate identified investments doesn't trigger and actual sale (gain/loss)?? Wow! Who else, other than Vanguard does this? It would be great if there was a way to look up a MFs ETF equivalent to do this kind of nontaxable swap. For me (any many of us, I'm sure), these long accumulated gains from holding MFs from years past is the main driver to often keep them as long as you can.

 

[donheff]

That's interesting. I get they may be equivalent, but the fact they are separate identified investments doesn't trigger and actual sale (gain/loss)?? Wow! Who else, other than Vanguard does this? It would be great if there was a way to look up a MFs ETF equivalent to do this kind of nontaxable swap. For me (any many of us, I'm sure), these long accumulated gains from holding MFs from years past is the main driver to often keep them as long as you can.

+1 I will look into this. I have VG index MF in taxable and assumed I was stuck.

 

[FANOFJESUS]

I think we all make investing mistakes at one time or another.

 

[disneysteve]

Now she agrees, no more MF in taxable accounts, and we are working on converting to all ETF's over the years.

I've never done anything with them because selling them would generate large capital gains since we've been in these funds for nearly 30 years.


One thing I should have done a long time ago but only did recently was to turn off reinvesting of income. That would have minimized the issue. Instead, we kept getting more and more shares over the years, making the year-end distributions larger and larger. I finally wised up and stopped that aspect at least.