Tax cost of rebalancing: strategy to minimize

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Topic Author
Bongleur
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Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

Not everyone has their money in tax-deferred accounts. Hitting a 5% rebalancing band can result in a significant capital gains tax when you sell the shares to make the swap.

How half-baked is this strategy to minimize taxes:

Suppose equities are down and you need to sell from your bond fund to make the swap. The NAV of the bonds has probably temporarily spiked due to the equity drop; so that gives you relatively more short term cap gains than usual to pay taxes on.

You also need to pay estimated taxes quarterly.

Instead of selling extra bonds to pay the taxes, wait at least 30 days (to avoid the wash sale rule) and preferably as long as possible to still make your estimated tax payment on time.

If equities are still going down, pay the taxes by selling specific shares of equities which have a capital loss. Since the cap loss partly offsets the bond cap gain, you sell fewer shares.

Since equities are still going down, it turns out that you rebalanced too soon. So paying the taxes from equity is preserving more "dry powder" on your bond side. Also the bonds have probably continued to go up in NAV, making them more valuable in your portfolio. Its also reasonable to ditch some stocks since equities are still going down -- you will buy them back at the bottom. "The trend is your friend."

If equities have recovered,the NAV of the bond fund has probably gone back to its "steady state" so there is relatively more long term cap gain to pay. But selling specific shares of equity at a loss might still be optimal. The new money from the 5% rebalance already has a gain so your allocation ratio of stock:bond might even be perfected by selling some equity.
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Default User BR
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Re: Tax cost of rebalancing: strategy to minimize

Post by Default User BR »

There is no wash sale rule for capital gains.

Why would you be paying estimated taxes? Small business? Then you should have a retirement plan of your own.

If you have steady income with a significant amount going to investments, you can probably rebalance strictly through new money.


Brian
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Bongleur
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Re: Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

What do you mean "no wash sale rule for cap gains?" Can you avoid it by selling specific shares?

Retired people with a 50:50 allocation don't have much new money.
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
Default User BR
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Re: Tax cost of rebalancing: strategy to minimize

Post by Default User BR »

Bongleur wrote:What do you mean "no wash sale rule for cap gains?" Can you avoid it by selling specific shares?
All the wash sale rule does is disallow taking a loss. If you sold for a gain, you could buy the holding immediately.
Bongleur wrote:Retired people with a 50:50 allocation don't have much new money.
A "fact" never specified in the original post. How common is it to have someone retired who has no tax-advantaged accounts? This is an extremely contrived "question".


Brian
Saving$
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Re: Tax cost of rebalancing: strategy to minimize

Post by Saving$ »

1. Consider all your assets one pool, and rebalance outside the taxable account.
2. Rebalance through new money going in.
3. If no new money is going in, and you are in the withdrawal phase, rebalance via withdrawals
4. A version of 3 - rebalance taxable funds via your gifts to charity. Instead of giving cash, give securities and give the ones that help rebalance.
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Toons
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Re: Tax cost of rebalancing: strategy to minimize

Post by Toons »

I avoid the tax cost of rebalancing by not selling assets.
I prefer allocating new monies or cap gains and dividends to achieve proper asset allocation :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
Topic Author
Bongleur
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Re: Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

>All the wash sale rule does is disallow taking a loss. If you sold for a gain, you could buy the holding immediately.

The scenario is that the equity fund is still going down. But I don't know how the wash rule works with specific shares. The share you buy as a rebalance have gone down, but you want to sell some (other, specific) shares to pay the tax bill. If those specific shares are a gain, no wash ?

Scenario: no tax advantaged account, no new money, no spending from the investment account, just rebalancing to try to accumulate.
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
redhounds
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Re: Tax cost of rebalancing: strategy to minimize

Post by redhounds »

While it's great to try and come up with original ideas, your plan is based on faulty interpretations of the tax code, a faulty premise (zero tax advantaged space yet in the accumation phase), and relies on knowing the direction of the market over the next 3-6 months.
--Red
Default User BR
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Re: Tax cost of rebalancing: strategy to minimize

Post by Default User BR »

Bongleur wrote:>All the wash sale rule does is disallow taking a loss. If you sold for a gain, you could buy the holding immediately.
The scenario is that the equity fund is still going down. But I don't know how the wash rule works with specific shares. The share you buy as a rebalance have gone down, but you want to sell some (other, specific) shares to pay the tax bill. If those specific shares are a gain, no wash ?
If you don't have a realized loss, then the wash rule is not applicable.


Brian
Default User BR
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Re: Tax cost of rebalancing: strategy to minimize

Post by Default User BR »

Bongleur wrote:>All the wash sale rule does is disallow taking a loss. If you sold for a gain, you could buy the holding immediately.

The scenario is that the equity fund is still going down. But I don't know how the wash rule works with specific shares. The share you buy as a rebalance have gone down, but you want to sell some (other, specific) shares to pay the tax bill. If those specific shares are a gain, no wash ?
If you don't have a realized loss, then the wash rule is not applicable.


Brian
DSInvestor
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Re: Tax cost of rebalancing: strategy to minimize

Post by DSInvestor »

What are you doing with dividends? Do you reinvest or do you collect them for spending/rebalancing? Those dividends, if collected, can reduce the need to sell shares when rebalancing.
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Bongleur
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Re: Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

redhounds wrote:While it's great to try and come up with original ideas, your plan is based on faulty interpretations of the tax code, a faulty premise (zero tax advantaged space yet in the accumation phase), and relies on knowing the direction of the market over the next 3-6 months.
Wash rule is just a detail affecting timing. Taxable & accumulating in this account is real world. Relies on looking back at the direction of the market.
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
redhounds
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Re: Tax cost of rebalancing: strategy to minimize

Post by redhounds »

Bongleur wrote:
redhounds wrote:While it's great to try and come up with original ideas, your plan is based on faulty interpretations of the tax code, a faulty premise (zero tax advantaged space yet in the accumation phase), and relies on knowing the direction of the market over the next 3-6 months.
Wash rule is just a detail affecting timing. Taxable & accumulating in this account is real world. Relies on looking back at the direction of the market.
If one is accumulating, they can contribute to some form of tax-advantaged space, even if it is a non-deductible IRA.
Bongleur wrote:Its also reasonable to ditch some stocks since equities are still going down -- you will buy them back at the bottom. "The trend is your friend."
Is that what you mean by "relies on looking back at the direction of the market"? If it's not too much trouble, could you please let me know when the next bottom is so that I can change my allocation to 100% stock? I'd also like to know when we hit the next high so that I can immediately switch to 100% bonds. Thanks.
--Red
Topic Author
Bongleur
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Re: Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

>If one is accumulating, they can contribute to some form of tax-advantaged space, even if it is a non-deductible IRA.

Don't you need to contribute from Earned Income?
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
redhounds
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Re: Tax cost of rebalancing: strategy to minimize

Post by redhounds »

Bongleur wrote:>If one is accumulating, they can contribute to some form of tax-advantaged space, even if it is a non-deductible IRA.

Don't you need to contribute from Earned Income?
You said they were accumulating. Therefore, by the definition that most people use for the accumulation phase, they are earning income which they then save a portion of so that it will accumulate. Just to make sure, I Googled it, and sure 'nuff, I'm not the only one with this definition: http://www.investopedia.com/terms/a/acc ... z2A4FOeQfa
--Red
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Bongleur
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Re: Tax cost of rebalancing: strategy to minimize

Post by Bongleur »

You keep trying to deny what I stipulated. People can pay all their expenses from pension & SS; investment therefore accumulates. Trust funds might be required to accumulate. Plenty of elderly never created IRA accounts.

I'm sick & tired of people who insist that tax advantaged accounts are universal.
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
redhounds
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Re: Tax cost of rebalancing: strategy to minimize

Post by redhounds »

Bongleur wrote:You keep trying to deny what I stipulated. People can pay all their expenses from pension & SS; investment therefore accumulates. Trust funds might be required to accumulate. Plenty of elderly never created IRA accounts.

I'm sick & tired of people who insist that tax advantaged accounts are universal.
Edited to add--You didn't stipulate many (any??) of these things in your original post.

I've never said that tax advantaged accounts are universal. You've set up a straw man and beat the hell out of him. Congratulations. If you want to force me to agree that your plan is not "half-baked" as you said in your original post, it's not going to happen. Every time someone points out a problem with your strategy, you change the rules or definition of concepts such as the wash sale rule and accumulation phases. Someone who has all of their expenses paid by a pension and SS is not typically a person that would be defined as being in the accumulation phase. No offense meant to you or your idea, but if it were as good as you apparently think it is, don't you think that at least 1 person would have jumped in and said so? I'm done arguing with you on this thread. I'm out.

I visit this forum because it one of the only forums free from religious and political crap and the forum members are almost always respectful and polite, even when they may disagree. If I have been less than polite, I do apologize.
--Red
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BHCadet
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Re: Tax cost of rebalancing: strategy to minimize

Post by BHCadet »

DSInvestor wrote:What are you doing with dividends? Do you reinvest or do you collect them for spending/rebalancing? Those dividends, if collected, can reduce the need to sell shares when rebalancing.
Good idea...
In taxable account, I've setup not to automatically reinvest any capital gains and dividends distributions.
Taxes are paid on these distributions anyway.
Use them to fund the assets that are under allocated.
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