How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

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Neus
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How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Neus » Thu Mar 08, 2018 11:37 pm

Hi Bogleheads,

I just realize that there's so called capital gain tax ready to hit upon liquidation which makes it liquidation is not as easy as selling but there will be tax consequences
  • Let's say that i start with 2 million USD at 2008, put it all at VT, and drawing 3% yearly, from backtest i'll have $4,208,305 now, which means there'll be unrealized capital gain of about 2,208,305
  • Let's say that i know for certain that next month the total stock market will DIP 15%
  • My tax bracket is 30%
So if i liquidate all now, i'll be paying capital gain tax 30% of $2,208,305 which is $662,491
While if i take the DIP i'll lose approximately the same amount $631,245

And it's only 10 year of unrealized capital gain, it'll get bigger with time

Therefore once we enter this for more than 7 years, liquidation won't be an option?

AlohaJoe
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by AlohaJoe » Thu Mar 08, 2018 11:39 pm

"Liquid" doesn't mean "can sell with no taxes"

mega317
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by mega317 » Thu Mar 08, 2018 11:57 pm

Your situation (or hypothetical) is not typical. Most people's savings weren't entirely invested at one time, but were added gradually, and they don't sell all at one shot. That means purchases from 2009 would have large gains but you would also have some more recent purchases with much less gains to be taxed.

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Raymond
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Raymond » Fri Mar 09, 2018 12:14 am

The definition of "liquidity" has nothing to do with potential taxation of any capital gains.

Also, there is no current Federal income tax bracket of 30%.

The maximum long-term capital gains tax is 20%, since we are talking about an investment made ten years ago.

Sure, I'd rather not pay 20% of my gains in taxes, but that has nothing to do with my ability to actually sell the shares.
"Ritter, Tod und Teufel"

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Epsilon Delta
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Epsilon Delta » Fri Mar 09, 2018 12:19 am

There are multiple things wrong with this hypothetical.

1. VT did not yield 3% so you've been selling shares over the years. Your remaining basis is less than $2,000,000.
2. How do you get to a 30% capital gains tax rate?
3. The tax loss you get from selling is different in kind from the loss in value you get holding through the dip. In particular after you sell you no longer have unrealized capital gains and this reduces your future tax liability.
4. If you know with certainty the market will fall 15% in the next month there are far more profitable things to do with the information.

Neus
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Neus » Fri Mar 09, 2018 12:31 am

Epsilon Delta wrote:
Fri Mar 09, 2018 12:19 am
There are multiple things wrong with this hypothetical.

1. VT did not yield 3% so you've been selling shares over the years. Your remaining basis is less than $2,000,000.
2. How do you get to a 30% capital gains tax rate?
3. The tax loss you get from selling is different in kind from the loss in value you get holding through the dip. In particular after you sell you no longer have unrealized capital gains and this reduces your future tax liability.
4. If you know with certainty the market will fall 15% in the next month there are far more profitable things to do with the information.
Epsilon,

1. Yes it's oversimplified calculation to illustrate there'll be a quite significant unrealized capital gain
2. I'm a non resident alien and my home country (indonesia) is taxing international capital gain as income tax, and my bracket is 30%
3. I see, that's a good point
4. Can you elaborate? I can only think of buying options

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BeBH65
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by BeBH65 » Fri Mar 09, 2018 1:48 am

You might want to add to your OP that you are NRA and that the capital gains tax in your country is 30%.

Also, i understand from your other posts that the capital gain tax might seem doubly harsh to as you would be working with accumulating funds where the dividends are reinvested immediately without taxation. The whole

This is in some way similar as a (traditional?) IRA for US- residents where dividends are also not taxed immediately, but taxation is deferred till the moment one sells the investments.

Here are a few reflections.
1. Related to the dividends, you might want to think that 30% of the reinvested dividends is actually a tax amount that the government allows you to defer. It is actually government money that you borrow.
You could always use distribute funds to avoid the large taxation at the end :-).
An Accumulating fund has considerable benefits: the compounding is tax free, and in case of losses on the price your dividends and its taxes are disappearing for the capital gains tax.
2. Similarly, for the capital gain: you know you will need to pay the capital gains tax and hence only 70% is really yours.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

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Epsilon Delta
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Epsilon Delta » Fri Mar 09, 2018 4:16 pm

Neus wrote:
Fri Mar 09, 2018 12:31 am
Epsilon Delta wrote:
Fri Mar 09, 2018 12:19 am
There are multiple things wrong with this hypothetical.

1. VT did not yield 3% so you've been selling shares over the years. Your remaining basis is less than $2,000,000.
2. How do you get to a 30% capital gains tax rate?
3. The tax loss you get from selling is different in kind from the loss in value you get holding through the dip. In particular after you sell you no longer have unrealized capital gains and this reduces your future tax liability.
4. If you know with certainty the market will fall 15% in the next month there are far more profitable things to do with the information.
Epsilon,

1. Yes it's oversimplified calculation to illustrate there'll be a quite significant unrealized capital gain
2. I'm a non resident alien and my home country (indonesia) is taxing international capital gain as income tax, and my bracket is 30%
3. I see, that's a good point
4. Can you elaborate? I can only think of buying options
1. Fair enough.
2. There may be quirks in the Indonesia tax laws that make a difference. All I know about Indonesia taxes is what you have told me, so I can't really help. But if the Indonesian tax code is a model of simplicity and free of loopholes it is a rare and beautiful thing, and every country I have ever lived in would do well to copy it.

4. Yes, options, futures or some other derivative. By a rough calculation, buying puts with a strike price about 5% below the current price would give a >1000% return. There may be something even better. I don't recommend you do that, although you could in theory take a small position to book as insurance against the loss instead of selling and paying the capital gains tax. My real point is how rare and valuable advanced knowledge would be. If anybody actually had it they would have a magic money machine.

Neus
Posts: 73
Joined: Fri Sep 22, 2017 2:12 am

Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Neus » Fri Mar 09, 2018 11:38 pm

Epsilon Delta wrote:
Fri Mar 09, 2018 4:16 pm
Neus wrote:
Fri Mar 09, 2018 12:31 am
Epsilon Delta wrote:
Fri Mar 09, 2018 12:19 am
There are multiple things wrong with this hypothetical.

1. VT did not yield 3% so you've been selling shares over the years. Your remaining basis is less than $2,000,000.
2. How do you get to a 30% capital gains tax rate?
3. The tax loss you get from selling is different in kind from the loss in value you get holding through the dip. In particular after you sell you no longer have unrealized capital gains and this reduces your future tax liability.
4. If you know with certainty the market will fall 15% in the next month there are far more profitable things to do with the information.
Epsilon,

1. Yes it's oversimplified calculation to illustrate there'll be a quite significant unrealized capital gain
2. I'm a non resident alien and my home country (indonesia) is taxing international capital gain as income tax, and my bracket is 30%
3. I see, that's a good point
4. Can you elaborate? I can only think of buying options
1. Fair enough.
2. There may be quirks in the Indonesia tax laws that make a difference. All I know about Indonesia taxes is what you have told me, so I can't really help. But if the Indonesian tax code is a model of simplicity and free of loopholes it is a rare and beautiful thing, and every country I have ever lived in would do well to copy it.

4. Yes, options, futures or some other derivative. By a rough calculation, buying puts with a strike price about 5% below the current price would give a >1000% return. There may be something even better. I don't recommend you do that, although you could in theory take a small position to book as insurance against the loss instead of selling and paying the capital gains tax. My real point is how rare and valuable advanced knowledge would be. If anybody actually had it they would have a magic money machine.
Epsilon

2. Yes i believe there is a way to wash the unrealized capital gain by being temporary permanent resident on capital gain tax free country, but not sure yet. But this is not abut me. This is about general bogleheads investment strategy and i see that a US person will pays 20% rate for long term capital gain, don't anyone think 20% is huge and want to avoid it? Especially at longer year when unrealized capital gain is getting huge.

4. I see, thanks for the info. I'll look further into options and futures. It's nice to have options without having to liquidate especially when the market is on 10 years bull run. But i think this will be against bogleheads principle of market timing/guessing.

Grogs
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Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Grogs » Sat Mar 10, 2018 9:04 am

Neus wrote:
Fri Mar 09, 2018 11:38 pm
Epsilon

2. Yes i believe there is a way to wash the unrealized capital gain by being temporary permanent resident on capital gain tax free country, but not sure yet. But this is not abut me. This is about general bogleheads investment strategy and i see that a US person will pays 20% rate for long term capital gain, don't anyone think 20% is huge and want to avoid it? Especially at longer year when unrealized capital gain is getting huge.

4. I see, thanks for the info. I'll look further into options and futures. It's nice to have options without having to liquidate especially when the market is on 10 years bull run. But i think this will be against bogleheads principle of market timing/guessing.
For #2, of course we all want to minimize the cap gains. For US citizens, there are a lot of things you can do.

- First, the long term (more than 1 year) cap. gains tax is actually graduated. 20% only applies to people with very high incomes. For most of us mere mortals the rate would be 15%, and for fairly low incomes (less than ~ $80,000 for a couple) the cap. gains tax is 0%. Note that you only pay the 15/20% for income above the threshold, so if you had ~$81,000 in cap gains and no other income, you'd only pay 15% on the $1,000 over the threshold - $150 total. So one can avoid a lot of the cap gains tax by spreading out the sales over several years.
- The second thing is that if your account is set up properly, you have different tax lots. Each lot will represent an individual purchase of shares, and will have it's own gains. So if you have to sell, you pick the lots with the least gain. If I needed to pull out $10,000 I would pick a lot for 2017 with a 5% gain (tax = ~$10,000*0.05*0.15 = $75) rather than one from 2009 with a 300% gain (tax = ~$10,000*0.75*0.15 = $1,125). A lot of people end up donating the shares with the 300% gains to a charity and selling less appreciated shares for income.
- Finally, if I'm paying a lot of cap. gains, it probably means I have a lot of income. All things being equal, I'd much rather be in a high-income, high tax situation than to run out of money.

I don't know how the specific tax laws are for Indonesian citizens. You might find someone who knows here if you put the key terms (capital gains taxes for an Indonesian living in the US) in the title of a thread, but you'll likely need to search for a group that has a lot of people in a similar positions to find the best solution.



For #4, I don't think ED is recommending you invest in options and futures, but just offering an example of how you could capitalize if you *knew* (i.e., you're a time traveler from the future) the market was going to drop. I would strongly recommend against it myself.

Neus
Posts: 73
Joined: Fri Sep 22, 2017 2:12 am

Re: How Index ETF is considered liquid when capital gain tax is ready to hit on liquidation

Post by Neus » Sun Mar 11, 2018 9:55 am

Grogs wrote:
Sat Mar 10, 2018 9:04 am
Neus wrote:
Fri Mar 09, 2018 11:38 pm
Epsilon

2. Yes i believe there is a way to wash the unrealized capital gain by being temporary permanent resident on capital gain tax free country, but not sure yet. But this is not abut me. This is about general bogleheads investment strategy and i see that a US person will pays 20% rate for long term capital gain, don't anyone think 20% is huge and want to avoid it? Especially at longer year when unrealized capital gain is getting huge.

4. I see, thanks for the info. I'll look further into options and futures. It's nice to have options without having to liquidate especially when the market is on 10 years bull run. But i think this will be against bogleheads principle of market timing/guessing.
For #2, of course we all want to minimize the cap gains. For US citizens, there are a lot of things you can do.

- First, the long term (more than 1 year) cap. gains tax is actually graduated. 20% only applies to people with very high incomes. For most of us mere mortals the rate would be 15%, and for fairly low incomes (less than ~ $80,000 for a couple) the cap. gains tax is 0%. Note that you only pay the 15/20% for income above the threshold, so if you had ~$81,000 in cap gains and no other income, you'd only pay 15% on the $1,000 over the threshold - $150 total. So one can avoid a lot of the cap gains tax by spreading out the sales over several years.
- The second thing is that if your account is set up properly, you have different tax lots. Each lot will represent an individual purchase of shares, and will have it's own gains. So if you have to sell, you pick the lots with the least gain. If I needed to pull out $10,000 I would pick a lot for 2017 with a 5% gain (tax = ~$10,000*0.05*0.15 = $75) rather than one from 2009 with a 300% gain (tax = ~$10,000*0.75*0.15 = $1,125). A lot of people end up donating the shares with the 300% gains to a charity and selling less appreciated shares for income.
- Finally, if I'm paying a lot of cap. gains, it probably means I have a lot of income. All things being equal, I'd much rather be in a high-income, high tax situation than to run out of money.

I don't know how the specific tax laws are for Indonesian citizens. You might find someone who knows here if you put the key terms (capital gains taxes for an Indonesian living in the US) in the title of a thread, but you'll likely need to search for a group that has a lot of people in a similar positions to find the best solution.



For #4, I don't think ED is recommending you invest in options and futures, but just offering an example of how you could capitalize if you *knew* (i.e., you're a time traveler from the future) the market was going to drop. I would strongly recommend against it myself.
Grogs,

I see, thank you for clearing that, if so it seems that most US person is not having this "liquidity" issue then, just Indonesian :(

0% cap in Indonesia is only $3800/year, compared to $80.000 in US.. That's why indonesian will quickly fill the bucket and hit 30%

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