Author Topic: Tax Gain Harvesting Problem  (Read 3430 times)

Cheddar Stacker

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Tax Gain Harvesting Problem
« on: February 03, 2014, 02:22:50 PM »
Does selling a stock in order to harvest capital gains generate non-qualified dividends that would otherwise have been qualified?

Does selling a mutual fund in order to harvest capital gains generate non-qualified dividends that would otherwise have been qualified?

Background: forum member Frankh recently retired. I offered my congratulations in his thread, and also offered some tax advice which led to a private message marathon. I understand the tax ramifications of this strategy, but my knowledge does not come from experience using this strategy, it comes from reading about it and understanding the tax law. So Frankh's last question stumped me, and here it is expert mustachians:

Quote
Re: Taxes
Sent to: Cheddar Stacker on: February 01, 2014, 08:22:01 pm Reply
Well this is interesting,

The fly in the ointment for tax gain harvesting is that in order to get qualified dividends your stock ownership has to meet the following critera.

Holding period.   You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

So basically if you get quarterly dividends, by tax gain harvesting you will essentially be turning  2 quarters of the qualified dividends into ordinary dividends and thus be taxed at the standard income rate.

Thoughts?

Frank

My answer to him was this question is outside my knowledge base and it would be good to post here, but I offered one guess related to mutual funds. My basic understanding is that with mutual funds this is not an issue since you are selling the mutual fund, not the stock underlying the fund. If the fund sells the stock, it creates non-qualified dividends for you. I'm not sure that's accurate, and I have no idea on the holding period question for stocks.

Any help in better understanding this issue would be appreciated by both of us. Has anyone here actually implemented this strategy yet with stocks or mutual funds? What have the results been? If you are creating non-qualified dividends by selling stocks how have you evaluated the net benefit?

Thanks in advance,

Cheddar

Exflyboy

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Re: Tax Gain Harvesting Problem
« Reply #1 on: February 03, 2014, 05:20:53 PM »
Thanks for posting this Cheddar,

I am thinking that this Qdiv loss has been created deliberately to discourage folks from using tax gain harvesting.

In thinking about this a little more I am wondering what advantage there is to TG harvesting in the first place.

 As we discussed, if you are in the 15% tax bracket you long term gains and qualified dividends are taxed at 0%, providing your total income from Q divs and long term capital gains is less than $75k or thereabouts.

So.. taking the worse case lets say you paid NOTHING for your stock.. then sold $75k's worth.. Its still taxed at 0% (assuming you got no dividends of any kind)..

Assuming one can live on less than whatever regular income (+401k to roth IRA conversions) that comes to less than about $20k.. PLUS $75k a year long term gains (hopefully thats all of us).. where is the advantage to do tax gain harvesting?

Maybe if you had to pull a swift $200k for some emergency its worth doing, but for normal levels of income it seems rather pointless.

What am I missing?

Frank

seattlecyclone

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Re: Tax Gain Harvesting Problem
« Reply #2 on: February 03, 2014, 05:48:37 PM »
The qualified dividend holding period is the 121-day period starting 60 days before the ex-dividend date. The period thus includes the 60 days before the ex-dividend date, the ex-dividend date itself, and the 60 days after the ex-dividend date.

This indicates to me that your dividends can be considered "qualified" even if you sell on the ex-dividend date, as long as you owned the shares for the previous 60 days before that.

Which brings us back to tax gain harvesting. I assume you're talking about harvesting long-term capital gains up to the top of the 15% bracket, right? If it's a long-term gain, then by definition you held the stock for more than 60 days before selling it. I would expect all of your dividends from the shares you sold should meet the "qualified" holding period.

The only risk of getting some non-qualified dividends would come when you buy back the shares after doing your tax gain harvesting. You now need to hold on to these shares for 60 days. If you don't, the dividends you received between when you bought back the shares and sold them again would not be qualified.

Cheddar Stacker

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Re: Tax Gain Harvesting Problem
« Reply #3 on: February 03, 2014, 05:52:47 PM »
The strategy provides great flexibility and numerous benefits. You are opening up the possibilities to create bigger capital losses if you also do some tax loss harvesting. You are increasing your cost basis to reduce your capital gain tax when you do sell at a profit eventually.

Let's assume you have $1M in value today in an after-tax brokerage account with a cost basis of $750,000. If you can harvest gains of $40K/year for 3 years (2014-2016) while the market is up 7%/year you'll have increased your FMV by $225K while increasing your cost basis by $120K, so you now have a FMV/cost of $1,225,000/$870,000. In this specific scenario your cost basis started at 75% of FMV. If you harvest $40K/year your cost basis is now 71% of FMV. If you fail to harvest $40K/year your costs basis is now 61% of FMV. That's a big difference.

Now in 2017 when the market tanks 12% and you harvest your losses, you can specifically identify the shares you want to sell and create a capital loss. Specifically, you just bought $120K of this investment over the last 3 years, and you can now sell it for a $14K loss. If it drops low enough I'm sure you could create a lot bigger loss. This loss can be used to reduce your current year capital gains if any, or it can be carried forward for many years and you can use $3K/year against ordinary income, meaning it can reduce your wife's salary or your rental property income.

You can also use this loss in the future when you sell your rental property, which will almost certainly create a capital gain much bigger than the $40K we're talking about here that you can do tax free each year.

Here's a link to a post describing the strategy and some of the benefits:
http://www.madfientist.com/tax-gain-harvesting/

I think I understand your question - if I'm always going to be in the 15% tax bracket why would I ever need a higher cost basis? These tax laws could change any day. I don't expect them to, and I've said as much on this forum recently, but it could happen. You will also eventually sell your rental property. You will eventually sell these stocks, or pass them on to a beneficiary. Your cost basis will eventually matter, even if it doesn't seem to now.

Exflyboy

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Re: Tax Gain Harvesting Problem
« Reply #4 on: February 03, 2014, 08:29:00 PM »
Interesting.. I had not considered the eventual sale of the rental property.

Maybe this is why my CPA was insistent that I only count the building itself as the rental as it is all on the same parcel of land as our primary residence.. The idea being that as it is a trailer (and thus its real value is depreciating hopefully faster than the depreciation schedule).. When I get to sell it it will show up as a loss rather than a gain, the land all belongs to the primary residence.

Either that or we will move into it for three years.

Sadly I got too much income in 2014 to stay inside 15%.. I hate it when that happens..:)

Frank

foobar

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Re: Tax Gain Harvesting Problem
« Reply #5 on: February 03, 2014, 08:38:42 PM »
It does not matter much to the 0% crowd but there are still a few cases where it is useful. Keeping your AGI low is good for ACA subsidies, college financial aid, and a couple of tax credits. And if you have enough losses you can use it to write off a couple thousand dollars of OI.

Is it worth the complexity of dealing with wash rules and the like? That is hard to say.


Thanks for posting this Cheddar,

I am thinking that this Qdiv loss has been created deliberately to discourage folks from using tax gain harvesting.

In thinking about this a little more I am wondering what advantage there is to TG harvesting in the first place.

 As we discussed, if you are in the 15% tax bracket you long term gains and qualified dividends are taxed at 0%, providing your total income from Q divs and long term capital gains is less than $75k or thereabouts.

So.. taking the worse case lets say you paid NOTHING for your stock.. then sold $75k's worth.. Its still taxed at 0% (assuming you got no dividends of any kind)..

Assuming one can live on less than whatever regular income (+401k to roth IRA conversions) that comes to less than about $20k.. PLUS $75k a year long term gains (hopefully thats all of us).. where is the advantage to do tax gain harvesting?

Maybe if you had to pull a swift $200k for some emergency its worth doing, but for normal levels of income it seems rather pointless.

What am I missing?

Frank