Author Topic: Understanding Taxable MF Capital Gains -- some questions  (Read 3077 times)

Flypaper

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Understanding Taxable MF Capital Gains -- some questions
« on: February 24, 2016, 02:14:19 PM »
Hello,

I have some questions about selling shares of a mutual fund.

If I want to liquidate a percentage of a taxable MF to pay tuition, pay down mortage, etc, will the selling of that stock affect my MAGI and thus my ability to contribute to a Roth (assuming the proceeds pushes me towards the Roth limit)?  If the answer is yes, is it normal to sell just enough so that one doesn't  cross the limit?

Also, assume that my capital gains are long-term and done via avg cost basis.  I no longer contribute to this MF, it was intended to be sold at some point (not for retirement).  Should I stop the auto-reinvestment?  I can't keep capital gains as long term if it is still reinvesting dividends, is my understanding correct?

Are there any tricks to minimizing the capital gains tax?  I don't have years and years of statements so I think I'm stuck with avg cost basis method.  If I wanted to try TLH, I need lot numbers, is that correct?

I'd really like to get this money out of stock and into some other liquid vehicle as the investment lifecycle is over (no new contributions), but in a manner that makes sense tax-wise if possible.  Suggestions?

Fund has ~50k, Vanguard 500 Index

Thanks for your thoughts!
 FP

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 4728
  • Age: 34
  • Location: Seattle, WA
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #1 on: February 24, 2016, 04:14:24 PM »
If I want to liquidate a percentage of a taxable MF to pay tuition, pay down mortage, etc, will the selling of that stock affect my MAGI and thus my ability to contribute to a Roth (assuming the proceeds pushes me towards the Roth limit)?  If the answer is yes, is it normal to sell just enough so that one doesn't  cross the limit?

Capital gains do count toward MAGI. You'll have to weigh the benefits of selling more stock against the benefits of making IRA contributions this year and determine what makes the most sense for your individual situation.

Quote
Also, assume that my capital gains are long-term and done via avg cost basis.  I no longer contribute to this MF, it was intended to be sold at some point (not for retirement).  Should I stop the auto-reinvestment?  I can't keep capital gains as long term if it is still reinvesting dividends, is my understanding correct?

This Bogleheads page indicates that the age of the shares is still relevant to the short/long term calculations, and oldest shares get sold first. This means only the shares that you bought by reinvesting dividends in the past year should count as short-term gains, and these would be the last shares you would sell.

Quote
Are there any tricks to minimizing the capital gains tax?  I don't have years and years of statements so I think I'm stuck with avg cost basis method.  If I wanted to try TLH, I need lot numbers, is that correct?

If you're selling all of your shares, it doesn't matter what capital gains method you use. If you're only selling some of your shares, the specific identification method will allow you the most control over how much gain you have when you sell some shares. Too bad you didn't save your statements; shares bought going forward should not suffer from this issue.

Quote
I'd really like to get this money out of stock and into some other liquid vehicle as the investment lifecycle is over (no new contributions), but in a manner that makes sense tax-wise if possible.  Suggestions?

Fund has ~50k, Vanguard 500 Index

Are you saying you're currently invested in the Vanguard 500 Index and that the fund is not accepting new contributions? I can assure you that this fund is alive and well.

Flypaper

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #2 on: February 25, 2016, 02:21:39 AM »
Thanks seattlecyclone for clearing that up for me.  It seems I might want to stop auto reinvesting if I want to avoid any short term gains taxes.  I read your blog post on back door Roth so I will investigate that as a potential option for making a Roth contribution in a year when I cannot make a Roth contribution if the MAGI is exceeded. ("Normal" contributions have irs limit, but backdoor do not, correct?)

You wrote:
Are you saying you're currently invested in the Vanguard 500 Index and that the fund is not accepting new contributions? I can assure you that this fund is alive and well.

Sorry, I meant that I was no longer making contributions.

Thanks again!

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 4728
  • Age: 34
  • Location: Seattle, WA
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #3 on: February 25, 2016, 07:54:21 AM »
Thanks seattlecyclone for clearing that up for me.  It seems I might want to stop auto reinvesting if I want to avoid any short term gains taxes.  I read your blog post on back door Roth so I will investigate that as a potential option for making a Roth contribution in a year when I cannot make a Roth contribution if the MAGI is exceeded. ("Normal" contributions have irs limit, but backdoor do not, correct?)

There's no income limit for the backdoor Roth. Just be sure you empty out your pre-tax traditional IRA (often accomplished by rolling it into a 401(k)) before you attempt it.

Interest Compound

  • Pencil Stache
  • ****
  • Posts: 658
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #4 on: February 25, 2016, 12:09:01 PM »
It seems I might want to stop auto reinvesting if I want to avoid any short term gains taxes.

This line of thinking doesn't make any sense. Taxes on investments are a GOOD thing, it means you made a profit! You're essentially saying, "I don't want an extra dollar in my pocket, because I want to avoid giving the government 30 cents."

Vanguards and Lentils

  • Bristles
  • ***
  • Posts: 288
  • Age: 28
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #5 on: February 25, 2016, 12:22:34 PM »
It seems I might want to stop auto reinvesting if I want to avoid any short term gains taxes.

This line of thinking doesn't make any sense. Taxes on investments are a GOOD thing, it means you made a profit! You're essentially saying, "I don't want an extra dollar in my pocket, because I want to avoid giving the government 30 cents."

I don't think that's the full story. Say I bought some number of shares >1 year ago, enrolled in dividend reinvestment, and at the end of 2016 sold all of that security. Whatever gains I had made through dividend reinvestment during 2016 would be subject to the short term capital gains tax. It seems to me that my tax bill would be smaller and simpler if I opted out of dividend reinvestment, and instead just tacked on that few extra dollars to my next purchase (which I would then hold onto for >1 year). At least for my tax bracket (15% short term, 0% long term), and my at-least-monthly frequency of making new investments, dividend reinvestment wouldn't make sense.

Interest Compound

  • Pencil Stache
  • ****
  • Posts: 658
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #6 on: February 25, 2016, 12:27:39 PM »
It seems I might want to stop auto reinvesting if I want to avoid any short term gains taxes.

This line of thinking doesn't make any sense. Taxes on investments are a GOOD thing, it means you made a profit! You're essentially saying, "I don't want an extra dollar in my pocket, because I want to avoid giving the government 30 cents."

I don't think that's the full story. Say I bought some number of shares >1 year ago, enrolled in dividend reinvestment, and at the end of 2016 sold all of that security. Whatever gains I had made through dividend reinvestment during 2016 would be subject to the short term capital gains tax. It seems to me that my tax bill would be smaller and simpler if I opted out of dividend reinvestment, and instead just tacked on that few extra dollars to my next purchase (which I would then hold onto for >1 year). At least for my tax bracket (15% short term, 0% long term), and my at-least-monthly frequency of making new investments, dividend reinvestment wouldn't make sense.

No need to make assumptions here. It's all math. Show us your math on both scenarios, and if you don't see your mistake, we'll point it out :)

Flypaper

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #7 on: February 25, 2016, 04:48:19 PM »
Quote
I don't think that's the full story. Say I bought some number of shares >1 year ago, enrolled in dividend reinvestment, and at the end of 2016 sold all of that security. Whatever gains I had made through dividend reinvestment during 2016 would be subject to the short term capital gains tax. It seems to me that my tax bill would be smaller and simpler if I opted out of dividend reinvestment, and instead just tacked on that few extra dollars to my next purchase (which I would then hold onto for >1 year). At least for my tax bracket (15% short term, 0% long term), and my at-least-monthly frequency of making new investments, dividend reinvestment wouldn't make sense.


No need to make assumptions here. It's all math. Show us your math on both scenarios, and if you don't see your mistake, we'll point it out :)

Thanks to  all for continuing the discussion.  I'm not sure of the math, and my situation is different than supermatthew because I'm in the 28% tax bracket.  But here goes with some numbers:

1636 total shares, current share price 55.00, all sold at an avg cost basis of 25.00, and it was all long term gains.
1636*55=90000 (Rounded up for simplicity)
1636*25=40900 cost basis

90,000-42500 = 49100 in LTCG.  49100 *.15 = 7365 taxes owed.  (if I waited one entire year and had turned off auto-reinvest)

Since I'm not making any new contributions but dividends are being reinvested, in 2015, let's say 25 shares were purchased via auto-reinvest.  1611 shares sold are LTCG, 25 are short term.
1611*$25=40275 (cost basis)

1611 shares long term = 1611*55=88605-40275=48830*.15=7324.00 in taxes owed

25 short term remain

25*$25=625
25*$55=1375

1375-625=750 short term gains *.28 = $210 taxes owed

7324+210 = 7534 in taxes owed (LTCG + short term)

all long term:                                7,365.00
most long term, some short term    7,534.00

Not sure if the math is right, but wouldn't this suggest to turn off auto-reinvesting?

WP


Interest Compound

  • Pencil Stache
  • ****
  • Posts: 658
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #8 on: February 25, 2016, 09:34:04 PM »
Quote
I don't think that's the full story. Say I bought some number of shares >1 year ago, enrolled in dividend reinvestment, and at the end of 2016 sold all of that security. Whatever gains I had made through dividend reinvestment during 2016 would be subject to the short term capital gains tax. It seems to me that my tax bill would be smaller and simpler if I opted out of dividend reinvestment, and instead just tacked on that few extra dollars to my next purchase (which I would then hold onto for >1 year). At least for my tax bracket (15% short term, 0% long term), and my at-least-monthly frequency of making new investments, dividend reinvestment wouldn't make sense.


No need to make assumptions here. It's all math. Show us your math on both scenarios, and if you don't see your mistake, we'll point it out :)

Thanks to  all for continuing the discussion.  I'm not sure of the math, and my situation is different than supermatthew because I'm in the 28% tax bracket.  But here goes with some numbers:

1636 total shares, current share price 55.00, all sold at an avg cost basis of 25.00, and it was all long term gains.
1636*55=90000 (Rounded up for simplicity)
1636*25=40900 cost basis

90,000-42500 = 49100 in LTCG.  49100 *.15 = 7365 taxes owed.  (if I waited one entire year and had turned off auto-reinvest)

Since I'm not making any new contributions but dividends are being reinvested, in 2015, let's say 25 shares were purchased via auto-reinvest.  1611 shares sold are LTCG, 25 are short term.
1611*$25=40275 (cost basis)

1611 shares long term = 1611*55=88605-40275=48830*.15=7324.00 in taxes owed

25 short term remain

25*$25=625
25*$55=1375

1375-625=750 short term gains *.28 = $210 taxes owed

7324+210 = 7534 in taxes owed (LTCG + short term)

all long term:                                7,365.00
most long term, some short term    7,534.00

Not sure if the math is right, but wouldn't this suggest to turn off auto-reinvesting?

WP

It looks like your two scenarios are flawed. Here's what I think you were trying to do:

Scenario 1: Selling everything after 1 year. Dividends taken as cash, as reinvestment was turned off.

Scenario 2: Selling everything after 1 year. Dividends used to buy more shares, as reinvestment was turn on.

Is this the case? If so why do they both have the same # of shares at the end? Scenario 2 should have extra shares at the end. You started Scenario 1 with 1636 shares, and started Scenario 2 with 1611 shares, why? You only ended up at 1636 after taking into account the extra dividend shares.

Scenario 1 should have X number of shares + some cash. Scenario 2 should have X number of shares + extra shares from the dividend. If you did the math properly, you should only be comparing the difference between the two scenarios. Let's do that:

Both scenarios have 1611 total shares to start, taxed as Long Term Capital Gains, so let's ignore that and focus on the differences:

Dividends reinvested - 25 shares taxed as short term capital gains.
Current dollar value: 25 (shares) times $55 (current price) = $1,375
Cost basis (to keep the math simple let's say price rose 10%, and steadily throughout the year): 25 (shares) times $52.50 (average cost basis) = $1,312.5
Taxable income: #1,375 - $1,312.5 = $62.5
Tax owed at 28% rate: $17.5
Total profit of dividend: $45

Dividends taken as cash - $1,312.50 (the same amount used in the above scenario to purchase shares)
Taxable income: $0 (it's cash, and we refuse to invest it to avoid taxes)
Tax owed at 28% rate: $0
Total profit of dividend: $0

Again, you're only taxed on profits. It doesn't make sense to eliminate profits, simply to avoid taxes.

Flypaper

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #9 on: February 26, 2016, 08:58:16 AM »
Quote
Is this the case? If so why do they both have the same # of shares at the end? Scenario 2 should have extra shares at the end. You started Scenario 1 with 1636 shares, and started Scenario 2 with 1611 shares, why? You only ended up at 1636 after taking into account the extra dividend shares.

I see what you did in your example, Interest Compound.  Yes, I was using the current situation, in that, I could turn off auto-reinvesting before March, and no new shares would be purchased.  That means 1636 shares (still) at the end of this year, or 1611 shares for long/ 25 for short term if sold this year.

In my scenario 1, I am forgetting the dividends received as cash.  That would ultimately be taxed though, wouldn't it, as part of my net income?  I guess I don't understand this part, if I received the dividend as personal income:
Quote
Taxable income: $0 (it's cash, and we refuse to invest it to avoid taxes)
Tax owed at 28% rate: $0
Total profit of dividend: $0

FP

seattlecyclone

  • Magnum Stache
  • ******
  • Posts: 4728
  • Age: 34
  • Location: Seattle, WA
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #10 on: February 26, 2016, 09:17:34 AM »
Dividends are taxed whether you reinvest them or not. The point is that you should not leave money in cash solely to avoid capital gains tax. It's better to earn a dollar and pay tax on it than to earn nothing and pay no tax.

On the other hand, if you want to sell your shares of that fund anyway, it doesn't make much sense to reinvest dividends in the same fund. Pick a different fund that better meets your long-term goals and invest the dividends there soon after they are paid.

Vanguards and Lentils

  • Bristles
  • ***
  • Posts: 288
  • Age: 28
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #11 on: February 26, 2016, 10:30:58 AM »
Dividends are taxed whether you reinvest them or not. The point is that you should not leave money in cash solely to avoid capital gains tax. It's better to earn a dollar and pay tax on it than to earn nothing and pay no tax.

On the other hand, if you want to sell your shares of that fund anyway, it doesn't make much sense to reinvest dividends in the same fund. Pick a different fund that better meets your long-term goals and invest the dividends there soon after they are paid.

Yup - the alternative to automatic dividend reinvestment should be to reinvest those dividends yourself, in a fund you plan to hold long term. But definitely not to let the cash just sit there.

dandarc

  • Magnum Stache
  • ******
  • Posts: 3312
  • Age: 36
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #12 on: February 26, 2016, 10:39:53 AM »
Dividends are taxed whether you reinvest them or not. The point is that you should not leave money in cash solely to avoid capital gains tax. It's better to earn a dollar and pay tax on it than to earn nothing and pay no tax.

On the other hand, if you want to sell your shares of that fund anyway, it doesn't make much sense to reinvest dividends in the same fund. Pick a different fund that better meets your long-term goals and invest the dividends there soon after they are paid.

Yup - the alternative to automatic dividend reinvestment should be to reinvest those dividends yourself, in a fund you plan to hold long term. But definitely not to let the cash just sit there.
And tying it all back together - the OP is not liquidating to reinvest in another fund - OP is liquidating to pay for some irregular expenses.  So keeping the dividends re-investing until the withdrawals are made should, on average (not talking market timing here), result in more money in OP's pocket, in spite of the short-term capital gains tax.

Interest Compound

  • Pencil Stache
  • ****
  • Posts: 658
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #13 on: February 26, 2016, 11:39:54 AM »
Quote
Is this the case? If so why do they both have the same # of shares at the end? Scenario 2 should have extra shares at the end. You started Scenario 1 with 1636 shares, and started Scenario 2 with 1611 shares, why? You only ended up at 1636 after taking into account the extra dividend shares.

I see what you did in your example, Interest Compound.  Yes, I was using the current situation, in that, I could turn off auto-reinvesting before March, and no new shares would be purchased.  That means 1636 shares (still) at the end of this year, or 1611 shares for long/ 25 for short term if sold this year.

In my scenario 1, I am forgetting the dividends received as cash.  That would ultimately be taxed though, wouldn't it, as part of my net income?  I guess I don't understand this part, if I received the dividend as personal income:
Quote
Taxable income: $0 (it's cash, and we refuse to invest it to avoid taxes)
Tax owed at 28% rate: $0
Total profit of dividend: $0

FP

My two scenarios only looked at the differences between the two. Either way you're paying taxes on the dividend, you can't avoid that. But you aren't paying any additional taxes if you leave it as cash, hence the $0.

You're paying additional taxes in the reinvest dividends scenario, because you have additional profits. As long as your tax bracket is less than 100%, it will never make sense to forgo profit in an effort to avoid taxes.

It seems you're still not convinced. Why don't you re-run your numbers and tell us which scenario ends up with more money in their pocket?

Flypaper

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: Understanding Taxable MF Capital Gains -- some questions
« Reply #14 on: February 26, 2016, 01:03:09 PM »
Quote
So keeping the dividends re-investing until the withdrawals are made should, on average (not talking market timing here), result in more money in OP's pocket, in spite of the short-term capital gains tax.

I am convinced now, Interest Compound, honest!  Thanks to dandarc and supermatthew for their comments also.   I'm always thinking more taxes is bad, when I should in fact be looking at the amount of money in my pocket.  I fully understand that leaving a distribution in cash (if that means I don't get a check in the mail for this, but somehow it is tied to the MF but in some cash bucket doing nothing, yes, I know that is not conducive to positive investing.  In my case if I stopped the auto reinvesting, I would take the check that was mailed to me -- that's what stopping the auto reinvesting means to me, that a check is mailed to me quarterly - and pay it toward a tuition bill or some other bills.)  Like dandarc pointed out, I'm looking to perhaps liquidate some/majority/all of it. It did well net over 18 years, it's time for it be utilized, perhaps liquidated (and freed from stocks) and moved to something safer. 

This has been a very beneficial discussion to me, thanks!

FP