Australian Capital Gains Tax (big hole?)

[investling]

Suppose you bought some shares at 400k that grew over 6 years at a steady rate of 100k per year to total 1 million. If you sold them after 6 years, you would have a 600k "CGT event", reduced by 50% for owning them more than 12 months, and thus a taxable income that year of 300k, largely allocated in the highest tax bracket. Right?

Alternatively, if after buying the 400k worth you waited 12.001 months (to get the 50% reduction) and then sold it all at 500k before immediately re-buying it all at the same price (500k), you would have a 100k CGT event in that first year, reduced by 50% to a taxable income of 50k, which would mostly be in the lower tax brackets. Repeat this each year for six years and you end up being 'taxed' on the same amount of 300k, but at much lower brackets by spreading it out across the years. If your income/earnings were low enough you could even avoid paying any tax on it at all by being under the ~18k taxable income threshold, whereas if you simply bought and held for decades you could be liable for enormous sums of tax even on very modest year-to-year growth. Am I missing something?

Selling everything and then immediately re-buying it once every 12.001 months seems like the only way to go, so why doesn't everyone do it? Or do they, and I just don't know about it? I must be missing something obvious here, I am very new at this so maybe I don't realize why this doesn't usually apply to people, but it seems like a crazy thing to encourage. Why wouldn't everyone do it this way?

[marty998]

You need to have 365 clear days between buy and sell. So 1.0055 years is the actual number.

Pedantry aside, a couple of points:

- The market doesn't go up in a nice straight line;
- You will incur (minor) brokerage costs;
- There are other ways of cutting CGT (selling over 2 years, making a deductible contribution to super, leaving it to an estate);
- Where are you going to get the $15k for the tax in the first year if you immediately reinvested the $500k? You would only be able to invest ~$485k in the second year....

(Edited for typo in tax cost)

[investling]

Thanks for the reply; I'm really interested in these sorts of 'obvious' points that I'm sure I must have missed... But it's hard to wrap my brain around the idea of the market not going up in a nice straight line and what kind of effects that would have on the incentives, it gets so complicated.

The other ways of cutting CGT: Are that how everyone else does it? Assuming that you wouldn't want to put the money in a super or estate where it can't be touched, selling it off over multiple years sounds interesting. The idea I guess is that you could shave pieces off and only pay the CGT on each piece at a time, keeping it low, but then you also would be unable to shift your investments from one set of shares to another without either paying the whole CGT all at once or spending several years doing the move piecemeal, right? So you're basically locked in to the one investment, it seems? I don't know what's worse...

[WerKater]

The main point you are missing is that capital growth is not linear but exponential. So, even if you had exactly the same growth each year, your 400k would not grow at 100k per year, but at 10% per year (I am just makiing up the specific numbers).

Scenario 1: Keep everything until the end, sell then:
 Year 0: 400k
 Year 1: 440k
 ...
 Year 7: 780k (400k*1.1^7)
Sell everything: Gain is 380k, taxable gain 190k. I am making up a marginal tax rate of 35% => 66.5k taxes. Total takehome: 713.5k

Scenario 2: Sell every year.
I am making up a marginal tax rate of 30%. So, the effective growth after taxes is 8.5% per year (10%-30%*10%/2)
 Year 0: 400k
 Year 1: 434k
 ...
 Year 7: 708k (400k*1.085^7)
=> Total takehome: 708k (since all taxes were already paid).

Scenario 1 wins (barely). The reason is that taxes were deferred in that scenario. However, if the assumed numbers are different (especially the tax rate), then the outcome can change. In reality it is much messier because the gains do not happen that nice and steadily.

In practice it is also unlikely that you will sell everything at the end of year 7.

[boarder42]

this is tax gain harvesting... not sure how it works in australia.  but jsut read up on tax gain/loss harvesting in your neck of the woods and you should find all your answers. 

[investling]

I mostly used the linear growth for simpler math, but your point (and marty998's) about how paying the tax 'ahead of time' leaves you with less to invest for the full duration is a good one. If the numbers were scaled down though, to the point that instead of paying a smaller amount of tax per year, you were actually getting your CGT events in beneath the ~18k zero-tax threshold (as would actually apply in my case - so this matters a lot to me!), that would seem to be a case where selling/rebuying is wise? You'd still lose a tiny amount on brokerage fees though...

[investling]

Another thought: this wouldn't actually be illegal in any way, would it? And I wonder how to keep track of a collection of shares of the same type, bought in pieces at many different prices over the years and then sold bit by bit as well. Can you say something like "these are the shares I bought in year X, not the more expensive ones of the same kind from year Y," and optimize for tax purposes? Or does it get averaged out somehow.

[marty998]

ATO can disallow a capital loss if you sell shares at a loss and immediately repurchase them.

They are more than happy to let you pay tax on gains however :)

And regarding selling bits and pieces, you have absolute discretion as to which parcels you nominate as being sold. There's no rule that says First in-First out (FIFO) or Last in- First out (LIFO). You can pick and choose what gives you the optimal tax outcome.

Given the market (generally) goes up, it is advantageous to do the LIFO method. Failing that, pick the one with the highest cost base.

[investling]

Yes, I've discovered that it's called a "Wash Sale" when you trying to sell it at a loss for tax reasons, and then they've got some rules to discourage that, but I think it's fine if you're selling at a gain even if the gain is too small to trigger any taxes that financial year and thus purely helps avoid future taxes (minus brokerage fees...). Barring anything else I've missed I think it might really be a good idea to try it, at least for now. The math gets complicated when your investments are big enough that it means paying actual taxes early and taking money out of the investments, but otherwise... Still, I wonder why nobody talks about it?

[boarder42]

just go look up tax gain harvesting that is all youre doing its the opposite of tax loss harvestnig its not illegal its not some big new loop hole you found there are piles of blog posts and articles about tax gain harvesting.

https://www.google.com/webhp?sourceid=chrome-instant&ion=1&espv=2&ie=UTF-8#q=tax%20gain%20harvesting

let me google that for you wasnt working so here's the straight link.

[boarder42]

the reason people arent doing this when they are working is b/c they are typically already in higher brackets.  in the US which i know is different i'm currently in the 25% tax bracket so selling would get al LTCG's taxed at 15% vs if i wait til i retire and we're in the 15% bracket i would pay 0 in taxes when i sell for every day life use.  I will also be selling up to the 15% tax bracket point on anything extra in my accounts after starting my roth ladder and allowing for my spending that year. 

you didnt crack some secret code ... but it is something good to learn about now go click on some of those links in the above google search.

[investling]

Thanks, I've been reading since you first mentioned it above, it's just strange that I've never heard of it before. I've spent so much time with books and websites like this one that purport explain these kinds of basic ideas to people who don't know better yet, and yet I still had to come up with it on my own and then randomly ask around to find out it was real. Unknown unknowns...

[boarder42]

there are accounts that get paid big money to exploit tax loop holes for clients.  they may not all be writing about it but f there is a loop hole people are already leveraging it.