Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
david3213
Posts: 16
Joined: Mon Apr 29, 2019 1:35 pm

Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by david3213 » Wed Jun 05, 2019 11:08 am

I'm in the process of unwinding my portfolio and have decided I need to take a capital gains hit rather than continue to keep my assets in high expense ratio mutual funds. However, I'm going to spread out this over several years so that I don't exceed the various thresholds. It appears that there are several key thresholds:

1. Net investment income tax of $250,000 for married filing jointly
2. 20% capital gains threshold of $434,551
3. Child tax credit phaseout of $400,000

My goal is to stay under the lowest threshold of $250,000. So, this means that I need to project my expected income for the year. Am I correct in doing the following:

1. Add together my salary and my wife's
2. Subtract our 403b, 457b and TSP contributions
3. Subtract the standard deduction
4. Estimate how much I think I will get in consulting income
5. Subtract 20% of this consulting income since I will be putting it in a profit-sharing i401k.

A few questions:

1. Should I also subtract 20% for QBI (qualified business income) from my consulting income?
2. Should I subtract the "employer" portion of the self-employment tax (i.e., half of 15.3% of my consulting income)?

Am I missing anything else?

kaneohe
Posts: 5670
Joined: Mon Sep 22, 2008 12:38 pm

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by kaneohe » Wed Jun 05, 2019 4:49 pm

Be sure that you know which income the various factors are based on:
1)NIIT is based on AGI so do not put the std deduction in the picture
2)CG thresholds are based on taxable income so should take deductions into acct
3)CTC phaseout is based on MAGI that for most will be AGI but check that you aren't affected by factors that will change MAGI
p.4 https://www.irs.gov/pub/irs-pdf/p972.pdf

ExitStageLeft
Posts: 1412
Joined: Sat Jan 20, 2018 4:02 pm

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by ExitStageLeft » Wed Jun 05, 2019 5:46 pm

Do you have your 2018 tax return for reference?

Are you younger than 62? If not then you need to keep the Medicare IRMAA premium tiers in mind.

User avatar
grabiner
Advisory Board
Posts: 24401
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by grabiner » Wed Jun 05, 2019 6:31 pm

You also need to weigh the cost of selling now against the cost of waiting. If you go over the NIIT threshold, you will pay 18.8% tax rather than 15%. But you expect the market to rise; if you have $1M of stock for which you paid $850K, it would be normal for the stock to rise to $1.038M by next January, so that you would pay 15% tax on a $188,000 capital gain instead of 18.8% tax on the $150,000 this year.

Another advantage of selling early is the asymmetrical tax treatment. If you sell now and the market crashes later this year, you can sell your replacement funds for a capital loss to offset your gain, so you are no worse off than if you had waited. If you don't sell now and the market booms later this year, you will have an unusually large capital gain.

Thus it is probably worth selling everything with a relatively small capital gain; any shares with a gain of 30% or more may be worth waiting to sell (or not selling at all if you use them to donate to charity).
Wiki David Grabiner

Topic Author
david3213
Posts: 16
Joined: Mon Apr 29, 2019 1:35 pm

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by david3213 » Thu Jun 06, 2019 3:22 pm

grabiner wrote:
Wed Jun 05, 2019 6:31 pm
You also need to weigh the cost of selling now against the cost of waiting. If you go over the NIIT threshold, you will pay 18.8% tax rather than 15%. But you expect the market to rise; if you have $1M of stock for which you paid $850K, it would be normal for the stock to rise to $1.038M by next January, so that you would pay 15% tax on a $188,000 capital gain instead of 18.8% tax on the $150,000 this year.
That's a fair point. It's further complicated by the fact that my state tax rate would be 9%. To make sure I understand what you're saying, let me work through an example. If a fund has an ER of 0.8%. Vanguard funds have an ER of ~0.1% or less. So, I am paying an extra 0.7% in expenses. For a $200k investment, that's $1,400/year extra in expenses. If I have $40,000 in unrealized capital gains, that's $11,480 in taxes (i.e., 18.8% Federal + 9.9% state giving me a total "tax cost" of 5.7%). So, it would take me 8.2 years to recover the difference, correct? That's still well within my investment time window.
Another advantage of selling early is the asymmetrical tax treatment. If you sell now and the market crashes later this year, you can sell your replacement funds for a capital loss to offset your gain, so you are no worse off than if you had waited. If you don't sell now and the market booms later this year, you will have an unusually large capital gain.
Fair point. Unfortunately for one of my funds, I have to wait because the AUM advisor used TLH at the end of last year. So, I can't sell until next year anyway if I want to take advantage of LTCG.
Thus it is probably worth selling everything with a relatively small capital gain; any shares with a gain of 30% or more may be worth waiting to sell (or not selling at all if you use them to donate to charity).
The example I gave in the first section is the one with the biggest LTCG (20%).

User avatar
grabiner
Advisory Board
Posts: 24401
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by grabiner » Thu Jun 06, 2019 8:15 pm

david3213 wrote:
Thu Jun 06, 2019 3:22 pm
grabiner wrote:
Wed Jun 05, 2019 6:31 pm
You also need to weigh the cost of selling now against the cost of waiting. If you go over the NIIT threshold, you will pay 18.8% tax rather than 15%. But you expect the market to rise; if you have $1M of stock for which you paid $850K, it would be normal for the stock to rise to $1.038M by next January, so that you would pay 15% tax on a $188,000 capital gain instead of 18.8% tax on the $150,000 this year.
That's a fair point. It's further complicated by the fact that my state tax rate would be 9%. To make sure I understand what you're saying, let me work through an example. If a fund has an ER of 0.8%. Vanguard funds have an ER of ~0.1% or less. So, I am paying an extra 0.7% in expenses. For a $200k investment, that's $1,400/year extra in expenses.
And if you wait half a year and the market rises by 3% (8% annual market rise minus 2% dividends, for half a year), that's also 0.72% in increased capital gains, so you are looking at $1420 in extra cost for waiting half a year to sell. That would be break-even if your gains are $37,000 and selling this year costs you 3.8% tax.
If I have $40,000 in unrealized capital gains, that's $11,480 in taxes (i.e., 18.8% Federal + 9.9% state giving me a total "tax cost" of 5.7%). So, it would take me 8.2 years to recover the difference, correct? That's still well within my investment time window.
This argument says that you should sell now rather than not at all; the computation above is whether you should sell this year or next year.

And the actual argument for selling now rather than not at all is even stronger than your example shows. If you switch funds now, you will increase your basis by $40,000, so you will reduce your capital gain by $40,000 when you sell the replacement fund. (The current fund may also be tax-inefficient.)
The example I gave in the first section is the one with the biggest LTCG (20%).
And the math above says that you should sell everything else for a capital gain, but you might wait until January on this fund, and you should certainly wait on any fund you can't sell until the gains become long-term. If the market happens to drop soon, you can sell for a now-reduced capital gain rather than waiting until January; if it doesn't drop, sell in January of next year regardless of the gain.
Wiki David Grabiner

Topic Author
david3213
Posts: 16
Joined: Mon Apr 29, 2019 1:35 pm

Re: Tax questions when converting advisor-managed portfolio to indexed portfolio (i.e., minimizing capital gains)

Post by david3213 » Tue Jun 11, 2019 12:28 pm

grabiner wrote:
Thu Jun 06, 2019 8:15 pm
And if you wait half a year and the market rises by 3% (8% annual market rise minus 2% dividends, for half a year), that's also 0.72% in increased capital gains, so you are looking at $1420 in extra cost for waiting half a year to sell. That would be break-even if your gains are $37,000 and selling this year costs you 3.8% tax.
Thank you for walking me through the math! I have gone ahead and sold all my long-term gains (and any short-term gains I could offset with losses). All that's left are two funds with large short-term gains, which I will sell as soon as I can next year (unless an opportunity comes up sooner).

Post Reply