TLH Question, does it always make sense?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Hiredgun
Posts: 166
Joined: Thu Sep 27, 2007 2:56 pm

TLH Question, does it always make sense?

Post by Hiredgun »

This is probably a stupid question, but I'll go ahead and ask anyway.

I'm not sure I always see the benefits of tax loss harvesting. Let's say I own $10,000 worth of VTSMX at the beginning of 2008. It's now worth $5,000 (just for example).

I can sell it and realize a $5,000 loss. Let's say I then reinvest the $5,000 (31 days later) back into VTSMX and the price hasn't moved much so I still get the same number of shares for the $5,000.

By the end of 2009, it has now climbed back to the original $10,000 as the market has improved. I sell it, so I've got a $5,000 capital gain. I can use my $5,000 loss against the $5000 gain, so a zero sum game.

NOW, assuming I had just held the fund the entire time (no selling or buying), I would have seen it decline $5,000 and then rise back to its initial $10,000 for a zero sum game.

What's the difference? If I'm long term buy and hold in the same funds, do I get that much of an advantage by TLH? What am I missing?
ruud
Posts: 765
Joined: Sat Mar 03, 2007 12:28 pm
Location: san francisco bay area

Post by ruud »

you received an interest-free loan from the government for a year by having to pay less taxes for 2008 (but more for 2009).

--ruud
.
livesoft
Posts: 86076
Joined: Thu Mar 01, 2007 7:00 pm

Post by livesoft »

Suppose I am able to deduct the loss and thus save 33% of the loss on my taxes. Then when I sell in the far future, I pay a long term cap gains tax rate of just 15%. Thus I get the government to pay 18% of my loss.

What you are missing is that for many folks the tax rate difference between marginal ordinary income and long term cap gains is substantial.

You have to engineer your transactions to take advantage of the tax rate differential. I'm not sure you did in your example which one would not really want to do.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Post by DSInvestor »

Hiredgun,

When you sold VTSMX and harvested 5K of losses, those losses could have offset capital gains you may have received. If you didn't get have any capital gains, you can use $3000 of the capital loss to reduce ordinary income. If you're in the 33% fed tax bracket, this saves you $1000 in taxes. if you're in 25% bracket, this would save you $750 in taxes. The 2K in losses that are unused will carry over to 2009. This happens even if you don't buy back VTSMX after 31 days. The key is the fact that you sold and had a loss.


In 2009, if you don't sell anything and have no gains, the 2K loss carry over will reduce your income tax again. If you do sell VTSMX (that you bought back for 5K) for 10K and have a 5K capital gain, the 2K loss carry over offsets the gain to give you a net capital gain of 3K (assuming the original losses were short term). ST losses can only offset ST gains, LT losses offset LT gains. So instead of paying capital gains tax on 5K, you pay it on 3K. You come out ahead in 2008 and in 2009.

If you simply held the shares through 2008 and 2009, you would have seen a full recovery in your example, and you would have been pleased. However, you would have paid more income tax for 2008 and 2009 since you didn't TLH.

When you bought the shares back after TLH, you now have much lower cost basis, which implies a potentially higher capital gain in the future if and when you sell. How those gains will be taxed in the future we can't say for sure, but we can certainly benefit from losses offsetting gains and reduced taxable income NOW.



Best regards,
Doug
Topic Author
Hiredgun
Posts: 166
Joined: Thu Sep 27, 2007 2:56 pm

Post by Hiredgun »

Thanks for the clear explanations, that makes alot more sense now.
AGR
Posts: 9
Joined: Sat Dec 27, 2008 2:39 pm

Post by AGR »

Is there anything wrong with taking the loss in 2008, parking the money in a money market fund and using the money to fund your 2009 Roth IRA. In that way, the capital loss will never be offset by a gain.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Post by DSInvestor »

AGR wrote:Is there anything wrong with taking the loss in 2008, parking the money in a money market fund and using the money to fund your 2009 Roth IRA. In that way, the capital loss will never be offset by a gain.
Nothing wrong with that - as long as you don't need the money on the taxable side perhaps for early retirement needs. If don't have taxable capital gains in the future, your capital losses will still reduce your taxable income for 2008 and beyond until you use up the losses - up to $3000 per year.

One warning though. If you're selling at the end of December and plan to fund the ROTH in JAN, make sure you don't buy the same stock/fund in the ROTH that you sold to harvest losses. That would be a wash sale and IRS will not allow the loss. You must wait at least 31 days after the sale to buy the same stock/fund back in ANY ACCOUNT. This only applies if you have a loss on the stock/fund. If you have a gain when you sell out of the taxable account, you can buy in ROTH immediately since IRS will never forgive a GAIN!!!

See http://www.fairmark.com/capgain/index.htm for details on capital losses and wash sales
Last edited by DSInvestor on Sat Dec 27, 2008 3:41 pm, edited 1 time in total.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Post by grabiner »

AGR wrote:Is there anything wrong with taking the loss in 2008, parking the money in a money market fund and using the money to fund your 2009 Roth IRA. In that way, the capital loss will never be offset by a gain.
If you can max out your Roth IRA (and won't need the money before you are eligible to withdraw it penalty-free), you should do that even if you have to sell a taxable account at a gain; the capital-gains tax on the sale will be outweighed by the future tax-free growth.
Wiki David Grabiner
kaneohe
Posts: 6786
Joined: Mon Sep 22, 2008 12:38 pm

Post by kaneohe »

OP might want to read this thread also since benefits of TLH will depend on individual situtation
http://www.bogleheads.org/forum/viewtop ... hlight=tlh
User avatar
AAA
Posts: 1885
Joined: Sat Jan 12, 2008 7:56 am

Post by AAA »

DSInvestor wrote:Hiredgun,
In 2009, if you don't sell anything and have no gains, the 2K loss carry over will reduce your income tax again. If you do sell VTSMX (that you bought back for 5K) for 10K and have a 5K capital gain, the 2K loss carry over offsets the gain to give you a net capital gain of 3K (assuming the original losses were short term). ST losses can only offset ST gains, LT losses offset LT gains. So instead of paying capital gains tax on 5K, you pay it on 3K. You come out ahead in 2008 and in 2009.
So, to follow your example, in 2008 you save $1000 in taxes if you are in the 33% bracket. In 2009, you pay $1000 taxes on the $3,000. Still cancels out, doesn't it?
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Post by DSInvestor »

AAA wrote:
DSInvestor wrote:Hiredgun,
In 2009, if you don't sell anything and have no gains, the 2K loss carry over will reduce your income tax again. If you do sell VTSMX (that you bought back for 5K) for 10K and have a 5K capital gain, the 2K loss carry over offsets the gain to give you a net capital gain of 3K (assuming the original losses were short term). ST losses can only offset ST gains, LT losses offset LT gains. So instead of paying capital gains tax on 5K, you pay it on 3K. You come out ahead in 2008 and in 2009.
So, to follow your example, in 2008 you save $1000 in taxes if you are in the 33% bracket. In 2009, you pay $1000 taxes on the $3,000. Still cancels out, doesn't it?
-If the capital gain on the sale in 2009 is short term gain, the two would seem to balance out if he's in the same tax bracket (i.e. save 1K in taxes in 2008, pay 1K in taxes in 2009).

-If the sale in 2009 was long term gain, that's taxed at a lower rate (15% for those in 25% bracket or higher, ZERO 10 and 15% brackets).


-If another fund in my taxable account were to give me a capital gains distribution (something I cannot control), the capital loss can offset those distributions and reduce my taxes.

-If he does not sell, and the loss carryover exceeds the net capital gains in 2009, he can use carryover to reduce taxable income again. Repeat until losses are used up.


edit: pretty tricky. original case wasn't laid out with clear by and sell dates to determine LT vs ST. The benefits are more clear for buy and hold taxable investors. For example, if I plan on holding VTSMX for the next 40 yrs and I can harvest a loss now and buy it back in 31 days, it works out great. As a tax efficient fund, I'm unlikely to see capital gains distributions in the future, so I may see many years of reduced taxable income as a benefit.

BTW, I used TLH as a way to dramatically clean up my portfolio. I had many actively managed funds and individual stocks with unrealized gains that underperformed the index funds. For years, I wanted to sell them to switch over to the index funds but I didn't want to pay the CG taxes - thinking that they didn't underperfom that much. Now that those stocks and funds have unrealized losses, it was a perfect opportunity to sell them and consolidate to Vanguard Index funds. I now have a cleaner more tax efficient portfolio and the consolidation allowed me to qualify for Admiral shares.
Post Reply