Big Capital Gains - what to do for tax efficiency?

[Zona]

We are in the lucky spot of having large amounts of capital gains in our taxable account. We are both FIREd but not yet 59.5 so this is our primary account for funding the next 7 years. Most of our holdings in this account are in SPY and we've got some good-sized lots from 2009 and a few from 2004 & 2005. All lots are five years old or more. For the past couple years we have been selling off newer lots with the least gain to live on and doing Roth conversions, so as of today there aren't any lots in this account that (currently) have a less than 100% gain and most of the lots are more like 200% plus gain. I'm not complaining, but I wonder if I could be managing our tax situation better going forward.

We hold 31% of our portfolio in Taxable, 21% Roth, and 48% IRAs. Once DH hits 59.5 seven years from now we will begin withdrawing from IRA money directly. But until then, we are selling taxable lots to live on and doing Roth Conversions to whittle down the IRA balance but we are kind of winging it to figure out how much of each. I use Dinkytown to model what our tax situation will be but to be honest I'm having a hard time figuring out what would be optimal. I just adjust numbers for Conversions and Cap Gains in Dinkytown until we have enough cash to live on and push our Roth conversion amounts a little bit into the 22% tax bracket. I have a set amount "budgeted" for Fed taxes of about $13k that we pay via estimated tax payments so I just try to not go over that.

But I'm wondering if there is some amazing software that can help me better visualize if I should pick one year to skip Roth conversions and just do a massive Tax Gain Harvest and repurchase some newer lots, or if it's better to prioritize getting money out of the IRA and into the Roth while we have years to do so. Does Pralana Gold help with this kind of thing? Or if anyone knows a good method or software I would welcome any advice! Thanks!

 

[Route246]

You have a problem that is going to get zero sympathy from anyone other than people like me who have the same wonder problem. LOL.

That said, the most wonderful piece of software you can have is a spreadsheet. I have quite varied group of stocks and funds that I plan to liquidate 2025Q1 which is going to put me in all the top brackets for Fed and CA but I want to take the hit all at once and pay the bulk of the marginal in April 2025. I have come to terms with this rather than trying to finesse it and my CPA agreed that sometimes the most straightforward way is not necessarily the most optimal way but at our age and savings level it is not going to affect our quality of life or anything like that.

Congratulations on your problem, it is a nice one to have.

 

[SnowballCamper]

Enjoy paying long term capital gains tax rates until you're paying ordinary income tax rates on the traditional IRA. I set up a SEPP to draw down the IRA a bit before I get to 59.5, but I'm not doing any Roth conversions.

 

[audreyh1]

Living off appreciated equites is pretty nice! If little of your income is ordinary then you have a high bar before you pay 15% taxes on LT cap gains. Plus only part of what you sell is gains. I guess some of that space will be eaten up by your Roth conversions plus it depends on how much you need to sell to live on.

Don’t know about software for optimizing.

 

[SecondCor521]

It's a perennial topic over at Bogleheads, so if you google search you'll find a number of threads.

Both cap gain harvesting at a low rate and Roth conversions are often nice. Since they both fill up brackets, the question is what balance of each is nicest.

There is a tab in the Case Study Spreadsheet which lets you model the question: "0% LTCG or t->R". It's about the 13th tab from the left. You can find the latest version of the CSS at Case Study Spreadsheet updates. It also has a nice graph that helps you model your current tax return and evaluate what happens with additional Roth conversions.

After going through the model and discussing it with MDM (the CSS author, who posts over on MMM on the above thread and elsewhere), I personally decided to prioritize Roth conversions over LTCG. What I do is live off my taxable account by selling monthly, then in December I use the CSS to figure out how much I can Roth convert while still paying "reasonable" tax rates given what I expect my tax rates to be later. Roughly speaking, I expect to be paying combined rates later in the high 2x% range. So I convert now up to the low- to mid-2x% range.

But my situation is probably different than yours - my relative percentage of gains was not as high, and I am single. Our ages and tax rates probably differ as well. So the model might recommend LTCG over Roth conversions for you.

 

[FLSUnFIRE]

My taxable has a very low cost basis having harvested losses in the '08 meltdown. I live pretty frugally so I'm doing very ok tax-wise and leave some 0% bracket on the table to get more PTC.... close to a wash tax-wise but I'm taking the PTC now while I can and it's a sure thing. If the PTC goes away, I'll gain harvest to the next bracket (and might also if I think the cap gains tax rate will rise in the future but that seems less likely than losing the PTC). I'm single so ROTH conversions along with realizing enough gains so I can live would kick me into paying >0% LTCG and losing PTC which is a pretty brutal marginal rate.

 

[robnplunder]

I had to replace a few mutual funds with a history of high capital gain to other ones. I aimed to reduce my income to the level I could get a full ACA subsidy. In 9 years (from age 54 to 63), I was successful for 8 years. The year I missed, a mutual fund changed its management team and it had a lot of turnover. This caused an unusually high capital gain payout. There was nothing I could have planned for. The fund had very low capital gain history hitherto. Anyway, the only thing I can suggest is to move mutual funds and stocks to lower capital gain paying ones.

 

[GrayHare]

If you make any charitable donations, consider donating some of the appreciated shares in kind. The cap gains won't be taxable income to you and if you itemize you'll get to deduct their appreciated value.

 

[grasshopper]

"The best laid plans of mice and men often go awry." Robert Burns.

Govt regulations kept us from overfilling tax advantaged investments. So when we retired at 54/50 we had equal amounts of investments in taxable and advantaged. We also had boatloads of LTCG in taxable investments.

Wanting to get rid of LTCG first because we have no heirs, for the first 10 years we sold gains. When I started early SS after a cancer DX we lost some opportunity, but had reduced LTCG to a level we liked.

The next 8 years we were converting to Roth accounts. Now I am taking RMDs and Ms G is taking SS and the conversion space has mostly gone away.

Meanwhile back at the ranch Mr Market has been so good to us that our T-IRA accounts even with conversions are larger than ever. Another problem to have, I am sure Uncle Sam will love us.

 

[mrfeh]

My taxable has a very low cost basis having harvested losses in the '08 meltdown. I live pretty frugally so I'm doing very ok tax-wise and leave some 0% bracket on the table to get more PTC.... close to a wash tax-wise but I'm taking the PTC now while I can and it's a sure thing. If the PTC goes away, I'll gain harvest to the next bracket (and might also if I think the cap gains tax rate will rise in the future but that seems less likely than losing the PTC). I'm single so ROTH conversions along with realizing enough gains so I can live would kick me into paying >0% LTCG and losing PTC which is a pretty brutal marginal rate.

Yup, PTC is the rub.

Spouse and I are 58 and forgoing any Roth conversions for now. In our situation, income from conversions would be "taxed" (via PTC reductions) at about 18%.

Will likely do some converting when we turn 65.

 

[RunningBum]

I was in a similar situation back when there was an ACA subsidy cliff. Distributions from a managed MF with high cap gains were going to push me over, so I skipped a year of ACA subsidies and sold that fund off. I bunched my future charity contributions by started a DAF with other highly appreciated shares, which gave me a large deduction that I could do yearly grants from. I also bunched any other tax deductions I could that year. That's getting me through a number of years without having to sell more.

If you are not taking an ACA subsidy there might not be a reason to do a bulk sale one year to avoid selling the other years. Just sell enough to live on. I haven't used Pralana gold but I'd guess it would help. I do a lot of spreadsheets to help with this kind of thing.

I have a set amount "budgeted" for Fed taxes of about $13k that we pay via estimated tax payments so I just try to not go over that.

That sounds like a very artificial barrier. I would disregard this limit. Usually the limit is income based, stopping at the top of a tax bracket, top of 0% cap gains, before an IRMAA tier, etc.

 

[Zona]

It also has a nice graph that helps you model your current tax return and evaluate what happens with additional Roth conversions.

Thanks SecondCor521, I'm a visual person so a graph showing me what my options are will be so helpful. I downloaded that CSS spreadsheet and it is something I will spend some time with this week. I am no spreadsheet-guru so I have many self-built ugly kludgy spreadsheets that I have been using that don't seem to have near the usefulness of this one. I read MMM's blog a couple times a year but haven't visited the forums there so I'll take some time to go through them as well. Thanks so much for this link and also for explaining what you prioritize and why.

Meanwhile back at the ranch Mr Market has been so good to us that our T-IRA accounts even with conversions are larger than ever. Another problem to have, I am sure Uncle Sam will love us.

That sounds like a similar situation to ours -- congrats to you on a long ER. Thanks for sharing what you did in the early years and why. We're in a very similar situation with no heirs. Main goal is to protect a widowed spouse from a major tax bomb and give us flexibility on tax planning. I've still got a lot to learn about how to plan for taxes though and don't want to make an unforced error that impacts us down the road.

That sounds like a very artificial barrier. I would disregard this limit. Usually the limit is income based, stopping at the top of a tax bracket, top of 0% cap gains, before an IRMAA tier, etc.

Yes, $13k for taxes is definitely an artificial barrier. During our earning years we were mostly self-employed and paid both Employer and Employee taxes, so "Taxes" were unpredictable and by far the biggest category of our annual spend. I have a hard time visualizing how the ordinary income and cap gains tax brackets work together, so when we ERd instead of targeting a specific bracket I just set an amount for "Tax Budget" that we could live with and went from there. But you make a very good point, and hopefully SecondCor's spreadsheet will help me to see what makes more sense tax-wise for our situation.

Thanks everyone for the replies. We just did our end-of-year AA rebalance and I realized how much we are winging it in terms of how we decide how much to Roth convert. We haven't done our conversion for 2024 yet so I thought now would be a good time to ask this question. Years from now when we are taking RMDs I don't want to have regrets that we missed an opportunity during these years when we have more control over our tax brackets. I understand it is a nice problem to have, definitely not complaining, but I love that this forum is actually a place where I can ask a question like this and get helpful answers. So thank you all.

 

[athena53]

I was feeling flush and moved a share of Costco into each of my grandchildren's UGTMA accounts a couple of weeks ago and I see now that they got MY basis. Not a concern right now since they're young (all 10 and under) and if/when then sell the first $1,250 of gain has no tax, the next $1,250 is taxed at their own rate (likely still zero) and only the remainder at their parents' rate.

If you're in a giving mood that's one way to get the gains off of your taxes. As others have noted, Donor-Advised Funds and giving in-kind (The actual stock or fund WITHOUT selling it) are also strategies I use.

 

[Graybeard]

Vanguard's Wiki has a section on tax efficient/tax inefficient investing, what funds to hold in tax advantaged vs taxable accounts. I have no solution to your current problem but the Vanguard Total Stock Market Index and Total International Stock Market Index are very tax efficient with very low turnover and minimal cap gains.

 

[Zona]

Thanks Graybeard for the reply. I had the dumb luck that when I started investing, I did not purchase mutual funds in my taxable brokerage but instead just ETFs like SPY and VOO. (This was not down to any skill or knowledge on my part -- I just picked the simplest ETF that I kind of understood that would require minimal research to know how my investments were doing). I should have been more specific in my OP -- the issue for me now is unrealized capital gains (the lots are old and cost basis is very low), not the kind of capital gains you get from Mutual Funds being churned.

 

[Graybeard]

Thanks Graybeard for the reply. I had the dumb luck that when I started investing, I did not purchase mutual funds in my taxable brokerage but instead just ETFs like SPY and VOO. (This was not down to any skill or knowledge on my part -- I just picked the simplest ETF that I kind of understood that would require minimal research to know how my investments were doing). I should have been more specific in my OP -- the issue for me now is unrealized capital gains (the lots are old and cost basis is very low), not the kind of capital gains you get from Mutual Funds being churned.

No I understood your problem, I have it too. Those 2 funds I mentioned have 100% cap appreciation. Fortunately I don't need to sell any shares and will be inherited at their cost basis.