Why the hand-wringing over tax efficiency?

[Cobra9777]

Learn from my mistake

I've held 15% real estate in the AA since ~2011... some single family rental homes and a REIT ETF, the latter held in tax-deferred. The results have been good and the rentals provided some nice tax advantages. I sold one of the rentals a couple years ago and decided I wanted to keep my overall 15% real estate allocation. So I used the net proceeds to buy the same REIT ETF in taxable, which produced income almost as good as the rental.

DON'T DO THAT !!

What a shock when the 1099 arrived... non-qualified dividends, huge capital gains, return of capital. I've since moved it to tax-deferred and all is right with the world once again. Even recognized a taxable loss in the process. Damage was fairly minimal for that one partial year.

Just thought I'd mention it here since most people focus on the tax-inefficiency of bonds in this context. But REITs are far worse. I clearly should have researched that more. But I was fixated on replacing the rental income and simplistically assumed it would be qualified dividends. Never paid attention to it in tax-deferred.

 

[ncbill]

I've held 15% real estate in the AA since ~2011... some single family rental homes and a REIT ETF, the latter held in tax-deferred. The results have been good and the rentals provided some nice tax advantages. I sold one of the rentals a couple years ago and decided I wanted to keep my overall 15% real estate allocation. So I used the net proceeds to buy the same REIT ETF in taxable, which produced income almost as good as the rental.

DON'T DO THAT !!

What a shock when the 1099 arrived... non-qualified dividends, huge capital gains, return of capital. I've since moved it to tax-deferred and all is right with the world once again. Even recognized a taxable loss in the process. Damage was fairly minimal for that one partial year.

Just thought I'd mention it here since most people focus on the tax-inefficiency of bonds in this context. But REITs are far worse. I clearly should have researched that more. But I was fixated on replacing the rental income and simplistically assumed it would be qualified dividends. Never paid attention to it in tax-deferred.

At least yours are publicly traded...I "got sold" non-traded REITs, BDCs, etc.

I'm now selling them for whatever they bring just to get rid of them (netting those losses against other investments' positive capital gains)

 

[pb4uski]

If one does it the way I read it, it sounds exactly like a wash sale into a tax deferred account. The loss is lost. ....

I read his comment is just being careful to avoid a wash sale so you don't lose the deductibility of the loss. This is usually pretty easy to do.

 

[marko]

I try to use tax efficient strategies but I don't worry about the last nickle. Some folks get real anal about taxes and invest in stuff that in the end pays less than what they could have gotten in taxable (but hey, they didn't have to pay any taxes)

+1 I think that's what OP is saying.

Paying taxes, whether at 15% or 25% "is what it is". I do my best but don't sweat the smaller stuff. I tend to stay locked in at a 14% effective rate which is what I focus on. If I drift up to 16% one year, well....I'll survive.

My dividends are what we live on and we have HY funds on both taxable and tax exempt sides.

 

[LOL!]

This is completely backwards.

[Qualified] Dividends are either tax free or taxed at 15%

Can't be non-qualified dividends if you want those tax rates.

 

[LOL!]

I read his comment is just being careful to avoid a wash sale so you don't lose the deductibility of the loss. This is usually pretty easy to do.

Exactly, don't buy the same thing in an IRA right after selling it for a loss in a taxable account. For example, sell Total Stock Market Index (TSM) in taxable for a loss, then buy S&P500 index in IRA; don't buy TSM in the IRA at that point in time.

Potential wash sales are another thing that seems to give people the heebie-jeebies.

 

[Austin704]

I am going to say that you might not have thought this through.

If I put HY in tax-deferred, then I can still use the dividends that it pays without withdrawing from tax-deferred. Here's how I would do that:

1. HY in tax-deferred. Tax-efficient stock fund in taxable.

2. HY pays dividend in tax-deferred.

3. Sell a few shares of tax-efficient stock fund in taxable in same amount as that dividend. Shares have been held long-term, so return of capital is tax-free and realized capital gains may be tax-free. Spend the money.

4. At same time as 3 above, use the dividend paid by HY to re-buy the stock fund shares in tax-deferred. You end up with the same total number of shares as before, but amounts in each account have changed slightly.

5. 1-4 above yield much less tax or no tax compared to what you are doing now. It's OK with me that you do what you do, but I thought you might like to pay less taxes for the exact same result.

Brilliant. I see the benefit in this. I do wonder whether step 3 should be adjusted to reflect the fact that the dividends in step 2 are tax-deferred and so on paper are worth more than they would be after-tax. In other words, would I calculate [HY dividend *(1-.22)] = $ to be sold in step 3? And in step 4, why wouldn’t I just reinvest the dividends into HY? Is this to effectively “rebalance” the stock:bond ratio, albeit swapping taxable for tax-deferred stocks?

 

[Austin704]

When one thinks of tax efficiency one has to consider how they get spending money. So it can make sense to have high yield bonds in a taxable account. It may be cheaper than pulling $ from an TIRA.

I did a roth conversion up to the top of the 24% bracket this year. Good long term tax move? maybe. It depends on how things unfold. Others manage income to get ACA subsidies. Good tax move? depends on how other things unfold.

It is easier to see what gave you a near term gain or loss. It is more difficult to see what a short term loss (no subsidy this year or doing a roth conversion) will change what happens in 10 or 20 years down the road.

Try to understand where you are getting hit with a tax. Then decide if that is better than other choices.

These are rules of thumb. You know if you have all your $ in TIRA's, they you do need to pull all your spending from your TIRA. Not tax efficient, but you don't have a choice. If you are 50/50 TIRA/Taxable, you have more choices. Work with what you have. Rules of thumb rarely know your specific situation.

Great advice. I’m seeing the picture now.

 

[Austin704]

For me, paying attn to taxable income avoids stepping into a 10% higher tax bracket...
"a penny saved is a penny earned", so thats a 10% return on those funds. Add in some other income level cliffs and my actual return is closer to 20%.

Compared to 3% investment return (stable value fund)... its not "hand wringing" its maximizing the return.
"Its not what you earn, its what you keep".

Fair enough. I’m humbled by the wisdom of the forum. I’ve spent a lot of time building up balances in tax-deferred accounts and taxable accounts for my “emergency” and “large purchase” funds, but I have not yet tackled the nuances of squeezing the last bit of value out of what I’ve worked hard to save by managing taxes. What you all are saying makes sense.

 

[Austin704]

Exactly, don't buy the same thing in an IRA right after selling it for a loss in a taxable account. For example, sell Total Stock Market Index (TSM) in taxable for a loss, then buy S&P500 index in IRA; don't buy TSM in the IRA at that point in time.

Potential wash sales are another thing that seems to give people the heebie-jeebies.

I fumbled my way into this problem myself once before, when I sold shares of a taxable bond fund at a loss and bought the same fund less than 30 days later. If I recall, doing so partially eliminated the loss I could claim against taxes.

 

[Austin704]

I try to use tax efficient strategies but I don't worry about the last nickle. Some folks get real anal about taxes and invest in stuff that in the end pays less than what they could have gotten in taxable (but hey, they didn't have to pay any taxes)

This was the thought that brought me to the original post! I’m seeing now that it is possible to have one’s cake and eat it too...

 

[Texas Proud]

Just to throw in a wrinkle.... a number of people are managing their income to maximize ACA credits so are not actually doing the best when it comes to maximizing investments...


IOW, when I reach a threshold for income where if I got more my credit would drop more than I want I have to live with what I can do... the net to me is still better, but just looking at what I did in the accounts might not look like it...

 

[LOL!]

Brilliant. I see the benefit in this. I do wonder whether step 3 should be adjusted to reflect the fact that the dividends in step 2 are tax-deferred and so on paper are worth more than they would be after-tax. In other words, would I calculate [HY dividend *(1-.22)] = $ to be sold in step 3? And in step 4, why wouldn’t I just reinvest the dividends into HY? Is this to effectively “rebalance” the stock:bond ratio, albeit swapping taxable for tax-deferred stocks?

Not surprisingly, someone wrote this up for you:
https://www.bogleheads.org/wiki/Tax-adjusted_asset_allocation

My tax rate is essentially 0% (a consequence of investing tax efficiently), so I don't do this.

Whether you reinvest your HY dividends back into HY is your choice, too. You get to decide for yourself whether are strict about following an asset allocation plan or not.

 

[RunningBum]

Just to throw in a wrinkle.... a number of people are managing their income to maximize ACA credits so are not actually doing the best when it comes to maximizing investments...


IOW, when I reach a threshold for income where if I got more my credit would drop more than I want I have to live with what I can do... the net to me is still better, but just looking at what I did in the accounts might not look like it...

Who are these people, and what are they doing that isn't the best financially?

Perhaps you think I'm one of those people. In 2017 I sold VG Primecap out of my taxable account because I could see that distributions were going to put me over 400% FPL within a couple of years. Primecap continued to do better than the index for 2018 and it did cost me some returns. However, I could not know it would continue to beat the market. I did not change my AA at all; I reinvested in index funds that Primecap beat. Primecap probably takes more risks, so that extra return does not come free. I can live with cashing out on a winner and going with index funds. Getting the best return for a particular year and managing your investments the best are not always the same thing.

 

[Austin704]

Not surprisingly, someone wrote this up for you:

https://www.bogleheads.org/wiki/Tax-adjusted_asset_allocation



My tax rate is essentially 0% (a consequence of investing tax efficiently), so I don't do this.



Whether you reinvest your HY dividends back into HY is your choice, too. You get to decide for yourself whether are strict about following an asset allocation plan or not.

That helps. So if I were to execute the strategy you described I would sell tax-efficient stock in my tax-deferred account and buy an equivalent tax-inefficient bond fund in that same account; then I would sell the HY bond fund in the taxable account and buy an equivalent amount of tax-efficient stock in that account. Then as the tax-deferred bond fund generates dividends I would sell taxable stock in an amount equivalent to the dividends from that bond to realize tax-efficient income, and use the dividends from the tax-deferred bond to buy an equivalent amount of tax-deferred stock (to maintain AA) or just reinvest them in the HY bond. I think I have that right. I can’t imagine performing this operation more than a few times a year!

 

[LOL!]

^Yes, with the caveat that it will be a little more complicated and take a little more time to set this up if you do not already have a tax-efficient equity fund in taxable.

The reason is that one would NOT want to sell for a short-term capital gain in taxable because that obviates the tax efficiency that one is trying to achieve. Selling for a loss is perfectly OK though.

I can think of a few ways to set this up from scratch, but they will all depend on one's personal situation.