Tad Borek wrote:
- quote -

I know mine, and I bet you know yours, too.

- quote -

You're absolutely correct, but the formula does not break down in my
view. Instead it is a point solution. To handle cases like you're
talking about you figure your gains in lots. This is not difficult.

- quote -

But think back 10 years ago to 1998, capital tax rates were heading
*down*. Not a time when you would employ this strategy with any confidence.

- quote -

True, and he's proposed raising everyone else's LTCG tax rates to 28%,
so for those not eliglble for the 0% tax bracket and planning to sell
soon they may take an extra 13% in the shorts. Where is that point?

- quote -

Not true, when you're looking out this far you will likely not get a
favorable solution from the equation I presented.

- quote -

But isn't this the very scenario we're talking about?

-Will

william dot trice at ngc dot com

Will Trice wrote:
- quote -

I don't know anyone that has a handle on those! I rely on commercial
software, it's too convoluted. BTW it's primarily for current-year
estimates - "what will the tax be if I sell this?" You can enter
assumptions for things like the AMT exemption, which has been amended
every year recently. You could project further but I don't find that
useful, the code changes too often.

A package like Turbotax could be a reasonable alternative, keeping in
mind year-to-year changes in tax laws.

The main point I want to make is that the tax rates aren't constant so a
linear formula will break down. It's correct for the incremental dollar
in gains at either end, but maybe at $1k in gains, maybe at $100k, it
will break down and go through several different rates. You could go
from a 0% to low-30% tax rates, which is significant.

- quote -

Here is a concrete example. Last year a retiree could donate their MRD
to charity, and gains in the 15% and below brackets were taxed at 5%. So
you might have retiree with a $750,000 IRA and substantial investments,
realizing $85k in gains and paying only 5% tax - perhaps only on a
portion of those gains. So the effective rate might have been in the
low-single digits. I certainly would not have foreseen that ten years
ago for someone with seven-figure net worth.

Similar issues come up with Roth conversions, but that's another topic!

Obama has proposed eliminating taxes for retirees with under $50k in
income. Not making a political point, it's just an example of a possible
change to the tax code that would have a very large effect on these
long-term projections. Suddenly the end-rate for capital gains would be
0% for a lot of people. Meanwhile you'd paid out 15% in taxes that
didn't continue compounding for maybe 10, 15 years or more.

Changes can work against you too, but you'd have to have a strong
opinion about where they're headed to accept a "certain" tax. Where is
that point? Back to Rich's question. For me, it would certainly be
tested if the preferable LTCG rate was to be eliminated, as it was in
the Reagan era tax code.

-Tad

Tad Borek wrote:

- quote -

Tad,
We may have to disagree on this. Someone attempting this strategy
should have a good handle on current real marginal rates for capital
gains including various AGI floors, etc. Given this, this person can
make a guess at future marginal rates that will probably be just as good
as your fancy sofware projections. After all, the software will have to
make assumptions as well. What's worse is that the assumptions may not
be explicitly stated limiting the ability of the user to play with the
assumptions to test different scenarios.

- quote -

Of course. And state and other taxes typically makes this strategy less
attractive since it is dependent on the ratio of the two tax rates.

- quote -

Again, we'll have to disagree. This is the same question that comes up
here with regards to Roth vs. deductible IRA/401(k) contributions.
Sometimes the Roth looks like a better choice, but that fails your
"delay taxes" rule.

This equation is perfectly valid, but requires valid inputs. Garbage
in, garbage out. But I think it is unlikely that if you make the
decision to step up your basis, you'll find yourself in an unexpected
tax position in the future that would have cut your taxes in half on the
gains to the point where the decision was made as you suggest above. It
could happen, though, especially if the "future" is a long ways ahead.
But then, with a good length of time, the math works against you anyway.
Typically good solutions will require selling relatively soon when tax
rates are somewhat more predictable anyway. Besides, the decision to
forgo this strategy may hurt you as well. Each person that considers
this as a viable strategy must assess the probability and magnitude of a
wrong decision.

And of course, you could get more gain than you expected, but most won't
cry about that!

-Will

william dot trice at ngc dot com

Re Will's equation below
- quote -

Tad Borek wrote:
[snip]
- quote -


Forgive me, but while I agree about tax rates (I noticed the same
phenomenon trying to run models for taxes and mortgage interest
deductibility), as far as I can see, once you have comparative taxes
rates, the equation itself works to provide a solution to the problem
presented. I haven't worked through the math to the equation yet, but
inputting numbers into it matches the spreadsheet results I have.

I think the point of the equation is that you have to have accurate
numbers to put into it, E.g. if you estimate a current tax rate of
22%, then estimate a future tax rate of perhaps 40% (both after the
adjustments for "Area 51 Tax Phenomena" you mentioned), and plug the
numbers into the equation, you have a valid comparison.

Will Trice wrote:
- quote -

Will,
It would be nice if there were a simple decision-making rule like that
but unfortunately it's not even remotely linear. I use software for
doing these projections because they're impossible to do any other way.
The problem is that the rate isn't really 15%, especially when gains
become significant. I didn't really get this until I started doing
projections for clients and saw how often you hit strange (higher)
marginal rates.

AMT can turn a marginal dollar of AGI into a 21-22% tax rate, by
slapping AMT on other income. Whether this happens is unpredictable
without knowing all the other specifics of the tax return but in CA it's
common. And a bunch of deductions are pegged to AGI so you end up with
odd marginal rates when you add a dollar of AGI (or AMTI) from capital
gains. Some examples: medical expense deductions, 7.5% AGI floor; misc
itemized deductions, 2% AGI floor; exemption & deduction phase-outs;
Social Security taxation; student loan interest deduction; PMI
deduction. It's uncommon to have all of them, but common to have some of
them, come into play.

And you have state taxes to consider, in most states -- with their
associated AGI effects. In CA it'd usually be 24.3% in the range where
the 15% federal rate applies. That's a lot of "certain" tax to swallow
for what is typically a "potential" tax benefit.

Point being I wouldn't rely on that equation to make this decision, you
could end up paying substantially higher rates for a marginal $1k of
capital gains - more than double, in certain scenarios. The simplest
ground rule of tax planning has no equation associated with it: "delay
taxes."

-Tad

dapperdobbs wrote:
- quote -

You are *much* too kind. That was Joe that mentioned 20 years since
he'd touched algebra - it's been over 30 for me (yikes!) so you should
definitely check my results, I've been busted here too often to count.

- quote -

I thought it more useful to not specify a gain mechanism, but rather a
total gain. This way someone can play around with volatility or
whatever and not be forced to use a potentially unrealistic constant
gain function (although that's probably perfectly fine for a first
approximation). If you really care about the derivation shoot me an
email at my cleverly encrypted email address in the sig below.

- quote -

A little over 4 years, but where are you going to get a consistent 20%
appreciation?

- quote -

This is a good point that I hadn't thought of.

-Will

william dot trice at ngc dot com

Will Trice wrote:

- quote -

Very nicely done! (Squeakless widgets!! I thought you'd said something
about not touching algebra for 20 years? Are you naturally good at
math, or ... are you like, using The Force?)

I'm still working on how you got the equation, but I like the
practical statement that "... if you expect to get more than ~120%
further gain before you ultimately sell, then stepping up the gain is
bad." For me, it takes the number of years out of it, focuses on the
expectation for the investment, and brings the math into practical
perspective - resolves and explains intuitive notions - and fits with
Buffett's famous pronouncement to the effect that he never sells. At a
20% appreciation, five to six years of holding is preferrable to
stepping up the gain.

Many rely on dividend payouts for their income. Depending on the
history of dividend increases, it's a much simpler problem to
determine how many years of increases it would take to restore the
loss of dividend income.

"Will Trice" <wtrice[at]notmonitored.com> wrote in message
news:47A4F137.5010002[at]notmonitored.com...
- quote -

I think you are saying the same thing. I think there is about a quadruple
negative floating around here!

inky dink wrote:
- quote -

I think you've got it backwards. As the future tax rate increases
("higher the tax increase") the more time you must stay invested before
the step up is not beneficial. In dd's example, if the new tax rate is
35% then the breakeven point will be in ~14.5 years. If you'll be
selling before that, then you want to step-up. If not, you don't.

-Will

william dot trice at ngc dot com

dapperdobbs wrote:

- quote -

<snip
- quote -

Yep, you've got it right. In the terms you've defined above, the
break-even point is when the following expression is true (neglecting
trading costs):

Ry = [T(1-P)]/[P(1-T)]

So for your example, if you expect to get more than ~120% further gain
before you ultimately sell, then stepping up the gain is bad. If you
expect less, stepping up is good. At a constant annual 8% rate of
return you'll reach break-even in a little over 10 years.

-Will

william dot trice at ngc dot com

- quote -

the higher the tax increase, the less time it takes to make up the tax
increase, no?


In the real world, even considering all
- quote -

dapperdobbs wrote:

- quote -

Yes. Your numbers were right, but the search for the pretty equation is
probably tough for anyone who hasn't touched algebra in 20+ years. And
since a spreadsheet makes it easy to see, I think your point was well
made. 8% - breakeven is 10-11 yrs.
So this decision is a bet on
a) cap gain rate going up (and the exact value of that new rate, one
variable)
b) market return
c) time until stock needs to be sold for good

JOE

Will Trice -

If my numbers are correct THIS time, you caught me being sloppy and
posting something mathematically incorrect - significantly incorrect -
I tried a shortcut that didn't work. I still find it hard to believe
that selling at 15% gives a significant advantage if tax rates
subsequently increase. But I have the equations below so anyone can
check them.

Two guys, Abe and Bill hold an indentical investment position with
100k long term capital gain. Abe sells in 2008 to pay a 15% tax rate
and immediately reinvests the remaining 85k. Bill simply holds onto
his existing position. The problem is to determine who ends up with
more cash in his pocket at some future date when they both sell. The
variables are the rate of return, the future tax rate, and the number
of years. Rich Carreiro specified "substantial" gains so I think it's
not unreasonable to assume a full 15% and full 28% effective tax rate.
I also think an 8% rate of return is reasonable.

Y = number of years
Ry = rate of return compounded over Y number of years (it should be a
superscript, representing the rate of return to the power of Y)
T = future tax rate
P = present tax rate

Bill = 100,000 x Ry x (1-T)
Abe = (100,000 x (1 - P) x Ry - 100,000 x (1 - P)) x (1 - T) + 85,000

In our example, P = 15%, T = 28%, R = 8%.

Y = 1 years (2009)

Bill = 100k x 1.08 x 72% = 77,760
Abe = (100,000 x 0.85 x 1.08 - 100,000 x 0.85) x 72% + 85,000 =
(91,800 - 85,000) x 72% + 85,000 = 89,896

In English, for Abe, first we reduce the capital invested by 15% tax
paid, then apply the rate of return. To determine the taxable portion
of that return, we subtract the established cost basis of 85k, then
take out the 28% tax leaving 72% of the new capital gain. Then we add
back the 85k cost basis to get final or total realized profit, so that
we can compare that total to Bill.. Abe = (85k x Ry - 85k) x 72% +
85k.

Y = 11 years (2019)

Bill = 100,000 x 2.331639 x 72% = 167,878
Abe = (100,000 x 0.85 x 2.331639 - 100,000 x 0.85) x 72% + 85,000 =
(198,189 - 85,000) x 72% + 85,000 = 166,496

There must be a more elegant formula for this, but I haven't found it
yet. I think the above works.

The higher the rate of return, the less time it takes to make up the
presumed tax increase, and conversely, the higher the increase in the
tax rate, the longer it takes. In the real world, even considering all
the variables and assumptions (the tax rate might be decreased, or
remain the same, for example), it does appear to make sense to at
least consider taking profits at the 15% rate. Clearly if one thinks
the market might drop, then realizing gains to establish a higher cost
basis would result in a capital loss that could be used to offset
other gains, and not simply a reduction of gains if the cost basis
remains untouched.

dapperdobbs wrote:

- quote -

Forgive me, but I still think you're missing the point. Rich is
suggesting that an investor with an appreciated asset, who plans to
continue holding that asset, could sell and rebuy that asset to lock in
a capital gain taxed at 15% under the assumption that the capital gain
tax rate will increase in the future. This can make sense depending on
the difference between the two tax rates and the amount of gain you
expect to have past the point where the 15% tax rate is no longer available.

-Will

william dot trice at ngc dot com

dapperdobbs wrote:

- quote -

You are ignoring the 0% cap gain rate. The only cost is the 2
commissions ($20?) plus the bid/ask spread (I was going to say 1/8, but
bid/ask is in cents now, so this will change depending on the stock,
let's assume 5-10 cents/share?)

A thousand share position sitting on a $5000 gain may cost $120 to
churn. That's a 2.5% hit, and is likely on the high side. Of course this
is made up. As long as this gain would be taxed in the owner's 10 or
15% bracket, for this year (through 2010) it's zero. Does this change
your thoughts on this approach?
JOE
www.blog.joetaxpayer.com

Will Trice wrote:

- quote -

You're right - I missed it, as you put it, maybe in part because Rich
Carreiro from previous postings is a sharp guy, and selling to
reinvest immediately doesn't make sense if my math is correct. E.g. I
think the math is to use the same percentage gain, but in alternative
a) reduce that percentage by 15% (an 8% estimate becomes 6.8%). It
isn't necessary, if I'm right, to consider the cost basis - only the
gain is relevant.

If on the other hand you are planning to re-allocate capital into a
substantially different investment (based on fundamentals), then you
might consider doing that a year early at 15% as opposed to waiting
for a presumed 28%.

Then Elle (of course) can compute the dividends one foregoes by
selling sooner.

"TB" <borekfm[at]pacbell.net> wrote
- quote -

Among other things, I was a tad more concerned that, say,
some retired single person, of minimal means apart from
his/her nest egg of stocks, would take your advice and end
up paying quite a bit more in taxes instead of less. Or,
since I do expect most reading here know to check with more
authoritative sources than Usenet, at least ultimately there
would not be a conflict between what you posted and what a
reader finds out later, muddying the waters of thought. The
point is to get bigger truths out, AFAIC.

The clarification is fine. Yes I knew this. It's not easy to
communicate concisely that it's the "bottom line" taxable
income that counts. Taxable income being what appears after
adjustments, deductions, and exemptions yada, and of course
including the LTCGs and qualified dividends. Go over 65,100
for MFJ, and the couple pay more, but of course only on the
excess above $65,100.

Some folks might find the calculator at
http://www.dinkytown.net/java/Tax10402008.html helpful to
estimate how much capital gain, qual divs, Trad IRA to Roth
IRA conversion etc. wiggle room they have before going from
0% to 15% taxes on LTCGs and qual divs.

On Jan 26, 7:33*pm, Rich Carreiro <rlc-n...[at]rlcarr.com> wrote:
- quote -

That's not quite correct, depending on how far back your way-back
machine can look. From 1913 to 1921, capital gains were taxed at
ordinary rates, initially up to a maximum rate of 7 percent. In 1921
the Revenue Act of 1921 was introduced, allowing a tax rate of 12.5
percent gain for assets held at least two years. From 1934 to 1941,
taxpayers could exclude percentages of gains that varied with the
holding period: 20, 40, 60, and 70 percent of gains were excluded on
assets held 1, 2, 5, and 10 years, respectively.

On Jan 29, 1:35*pm, dapperdobbs <George...[at]hotmail.com> wrote:
- quote -

The stock market is close enough to being efficient that one's
*opinions* of where a stock is headed should often be given less
weight than tax effects, which are more knowable.

Will Trice wrote:

- quote -

Will, I agree. Many tax situations apply to some subset of taxpayers.
The donating money straight from your IRA, for instance. I did this for
one client and haven't heard of too many jumping on this. (it's not an
option for 08).

In this case, I was using the rest of this same client's 25% bracket for
the Roth conversion "top off". I need to look at the numbers to see if I
should instead capture that same $$ as 0% cap gains.

JOE