Avoiding the Kiddie Tax on Capital Gains

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verbose
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Avoiding the Kiddie Tax on Capital Gains

Post by verbose »

My 13-year-old has a UTMA account with $2700 in unrealized capital gains because I transferred her into a new fund in early 2009 (which means she also still has a carry-over capital loss, but not nearly as much as the gain). I remember reading about the "kiddie tax" years ago, and I had in my head that it stopped applying after age 14. Apparently I missed the update: it now applies until age 19 or 24 (full-time student). Given that the account comes under her control at age 21... that kiddie tax still applies if she's a student (she had better be) and I don't want to turn this money over to her with a huge tax bill hanging over her head.

So, what if I sell a little bit of the fund each year (keeping the gain plus dividends under her standard deduction) and buy something similar? And what if the funds are so similar that they might even qualify as a wash sale if there were a loss? Everything I've read about wash sales says that there must be a loss, otherwise it's not a wash sale. I can't find anything in tax documents that suggests this is NOT allowed or penalized in some way.

She's 100% in VSMGX (Vanguard Moderate Growth). I don't really want to move the funds elsewhere, but if I don't sell and the market continues going up, she's going to have a nasty tax surprise. Due to fund minimums and desired asset allocation, I have to keep her in a single fund.

As I was writing this, I realized the best time to take action is probably in late December. I can sell some in late December and then some in early January to spread the gains over two tax years. At that point, the unrealized gain should be low enough not to trigger taxes, much less the kiddie tax. The carry-over capital loss will be used up, but there's no avoiding that. As it is, if I sold all of it in one year, there's already enough to trigger kiddie tax after the capital loss is used.

So, what is my question? Based on the above, am I right about this? Does this seem to be a sound strategy?
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rob
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Re: Avoiding the Kiddie Tax on Capital Gains

Post by rob »

Yeah, I always harvest GAINS in my kids UTMA's. I keep it under the kiddie tax limit. The long term objective for me is to give them the account with a loss or at least very small gain as possible.
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien
livesoft
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Re: Avoiding the Kiddie Tax on Capital Gains

Post by livesoft »

If it has a gain, one can buy the exact same fund without any wash sale issues. This is called tax-gain harvesting: http://www.bogleheads.org/wiki/Tax_gain_harvesting

OK, maybe Vanguard won't let you exchange into the same fund, so ping-pong back and forth between LifeStrategy and TargetRetirement.
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Rainier
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Re: Avoiding the Kiddie Tax on Capital Gains

Post by Rainier »

Exactly, harvest the gains to stay under the annual limit. Wash sales don't apply, but the fir may restrict the sell-buy
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verbose
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Re: Avoiding the Kiddie Tax on Capital Gains

Post by verbose »

Thanks, I didn't even realize it was in the Wiki! I will make sure to get this done.
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