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A few days left to take care of your portfolio gains and loses and minimize taxes. Does anybody sell losers from MF portfolio by year end to offset gains and reduce taxes? What pros and cons of doing that with MF? Does wash sale rule apply to MF?
Some years I do, others I don't. I look at AGI figures as well as how much tax I'm going to pay. There are reasons why one wants to control AGI (e.g. eligibility for Roth contributions, taxation of SS, etc.).
So my personal answer is: yes I sell losers to offset gains, but no, not necessarily for the purpose of reducing taxes.
Since I am focused on AGI, one of the cons of selling when one doesn't need the loss to reduce AGI below a threshold is that one does not have the loss available to use next year when one might need it.
Another con is that you cannot immediately repurchase the same, or substantially identical fund (e.g. swap one S&P 500 index fund for another, though there's never been a ruling on that). This is rarely a big deal as you can usually find a reasonable substitute. Still, if it's a unique fund you're selling ...
Wash sale rules apply to MFs, so you need to watch out for automatic reinvestments. I usually turn them off before I'm expecting to sell. Otherwise they can trigger wash sales. But if you're liquidating (permanently or at for least 30+ days), those reinvestments don't matter - you'll get the whole loss.
A pro of taking losses with MFs (as opposed to individual stock) is: if you sell before December distributions, you avoid getting taxable dividends. It comes out even (selling before or after distributions) if all the dividends are cap gains and qualified income. But if any of the divs are nonqualified income, you're better avoiding them by selling before the distribution.
With stocks, the dividends are generally qualified, so you can't reduce your tax liability the same way with this maneuver.
Another pro of doing loss harvesting with MFs as opposed to stocks: with MFs, you have a choice of average cost or actual cost. If you're selling in a down market, using average cost will reduce the cost of your short term shares (increasing your short term losses) and increase the cost of your long term shares (decreasing your long term losses). That's a good thing, since short term losses can be more valuable than long term losses.
As I tried to describe above, I don't agree with this, except as a simple rule of thumb if you don't want to get into more detailed calculations.
For example, suppose you are married. The 15% bracket goes up to $74,900. Suppose your taxable income (Form 1040 line 43, notordinary income) typically runs about $76K, including $2K of recognized cap gains.
Let's suppose you've got a loss of $2K that you are debating about taking (for tax purposes).
By assumption, you've got $74K of ordinary income, and $2K of cap gains. The first $900 of those cap gains are taxed at 0% (because $74K of ordinary income, plus $900 of cap gains is still below the 15% bracket limit of $74,900).
The other $1100 of cap gains is getting taxed at 15%.
If you recognize a loss of $1100, you get to save that 15% on the last $1100 of gain. Relatively speaking, a nobrainer. But if you choose to recognize your whole potential loss of $2000, the extra $900 in losses is wasted. It reduces your cap gains to $0, but the last $900 weren't getting taxed anyway, so what's the point?
Instead of having $900 worth of losses "in the bank" that you could recognize January 2, for 2016 taxes, you've squandered the opportunity by using those losses to reduce a gain that wasn't being taxed.
Similar reasoning applies at the 39.6% bracket, where cap gains rates transition again - here from 18.3% to 22.3%. You may be better off deferring the loss if it takes you below $464,850 in taxable income. A problem we should all have. I mention it simply to illustrate that it is not the 0% tax on cap gains that creates this situation, but any transition in tax rates.
There are other situations where recognizing losses may be suboptimal. The ones I'm familiar with follow this general pattern of crossing a threshold amount (often some form of MAGI).
Concur with msf on managing different aspects on tax loss and AGI. We like to put it on a spreadsheet and make enough Roth conversion without getting kick into the next income bracket. As such we like it take tax loss should be done throughout the year instead.
Thank you all for your answers. I still have some doubts selling funds to recognize loses. My specific situation is following: I started MF investing only1-2 years ago and practically all my MF purchased this year experienced loses after dividend payments and year end capital gain distributions. To recognize the loses I would need to close almost all my positions. Is it really a good idea? For examples my 2 best funds PRWCX and PONDX. Their prices now are the lowest in 2 years. That means all my contributions (including reinvestments from capital gains and dividends) to these funds during that time have loses. Do you recommend to sell them now with intension to purchase again in a month? (For closed to new investors PRWCX that probably means selling not 100%).
Depends on the size of the losses, value of those losses, opportunity costs.
Do you want to be out of the market for a month? Or if you move that money to other funds for just a month, what are you hoping for?
If you're hoping for a gain, then when you sell (to move the money back to your original funds) you'll have short term gains that will be taxed at ordinary income tax (not cap gains) rates, which somewhat defeats the purpose of the move. If you're hoping for the fund not to go up, then what's the point? (Though you would be able to claim any loss.)
If (in the case of PONDX) you're just looking for income (i.e. monthly dividend, not appreciation), how much do you expect to get in a month vs. getting 1% in a bank account? That difference is approximately your opportunity cost, give or take the risk of PONDX or your replacement fund changing in value over the next month.
It may be better to think of moving the money to other funds for a year (to avoid the short term gain problems). If the market goes up in 2016 you'll still wind up recognizing gains, but at least they'll be long term. You have to weigh that tax cost against the losses you'll recognize now.
Looking at PRWCX, the shares that lost ~10% might be worth selling; I'm not sure I'd sell shares bought at the beginning of this year (~4% loss) - a lot of risk (in moving money around, possible short term taxes, etc.) for a small write off. So if you do a partial sale, these are the shares I'd keep (more below).
PONDX is different for a couple of reasons. One is that the monthly div reinvestments this year have had small losses (2-3%). So you may be looking at smaller losses per share. On the other hand, moving money to a different bond fund and back may be "cheaper" - as I described above, you generally don't expect much appreciation from bond funds.
Still, it's a volatile fund in a volatile category - a similar replacement fund could go up or down a percent in a month. If it goes up, that's better than keeping the money in cash. If it goes down (and tracks PONDX) then you would have lost the money anyway, and meanwhile you realize the loss for 2016 instead of later. Not that much volatility for bond funds, even funds like this, so the risks are less in moving money around.
If you're going to do a partial sale (as with PRWCX), then I'd suggest telling your broker (or TRP if you're invested directly) that you want the cost basis to be actual cost (specific shares), with the default method specific shares and the secondary method being highest first or tax utilization. You need to do that a day or two before the sale - the brokers I've been dealing with won't switch from average cost to actual cost (any other method) in less than a day.
This is important because you want to maximize the losses you're recognizing. If you use average cost, then all the shares you sell will be treated as having the same cost - which means you'll be averaging in the cost of even those shares that went up in value. On the other hand, if you use an actual cost method, then the cost of the shares sold will be the real costs, which for many shares will be above the average.
You notify the broker, and then when you sell the shares (or the next day) you notify the broker which shares you sold. It's easiest doing it online at the time of the sale. The system will let you pick the shares you're selling, and you just check off the most expensive ones until you've picked enough shares. Or if you told the broker to sell highest first, this will happen automatically for you. That will maximize the loss you recognize.
One other point: reinvested dividends will create wash sales if you don't sell your full holding. That means that some of the losses won't be counted now. You don't lose them, you just defer them. It's not terrible, and these days, the broker will do the calculation for you. If you purchased 10 shares this month (through reinvestment or separate purchase), then the losses on the oldest 10 shares will be deferred (not counted now).
The bottom line is: is taking this loss now of enough benefit to be worth these maneuvers? Taking the losses now and buying back means that you'll have bigger gains to pay later (since you're resetting the cost at a lower price).
I took a fair number of losses this year, but most years I don't even though they're available to me. And I did it with funds that were easy to replace or ones that I wanted to get out of. Swapping back into equity (or volatile bond) funds entails risk and possible tax costs. It's an easier decision when one has a long term replacement fund in mind.
Comments
So my personal answer is: yes I sell losers to offset gains, but no, not necessarily for the purpose of reducing taxes.
Since I am focused on AGI, one of the cons of selling when one doesn't need the loss to reduce AGI below a threshold is that one does not have the loss available to use next year when one might need it.
Another con is that you cannot immediately repurchase the same, or substantially identical fund (e.g. swap one S&P 500 index fund for another, though there's never been a ruling on that). This is rarely a big deal as you can usually find a reasonable substitute. Still, if it's a unique fund you're selling ...
Wash sale rules apply to MFs, so you need to watch out for automatic reinvestments. I usually turn them off before I'm expecting to sell. Otherwise they can trigger wash sales. But if you're liquidating (permanently or at for least 30+ days), those reinvestments don't matter - you'll get the whole loss.
A pro of taking losses with MFs (as opposed to individual stock) is: if you sell before December distributions, you avoid getting taxable dividends. It comes out even (selling before or after distributions) if all the dividends are cap gains and qualified income. But if any of the divs are nonqualified income, you're better avoiding them by selling before the distribution.
With stocks, the dividends are generally qualified, so you can't reduce your tax liability the same way with this maneuver.
Another pro of doing loss harvesting with MFs as opposed to stocks: with MFs, you have a choice of average cost or actual cost. If you're selling in a down market, using average cost will reduce the cost of your short term shares (increasing your short term losses) and increase the cost of your long term shares (decreasing your long term losses). That's a good thing, since short term losses can be more valuable than long term losses.
The only thing I would add: its not necessarily a best practice to wait til year-end to do this...
Merry Christmas
For example, suppose you are married. The 15% bracket goes up to $74,900. Suppose your taxable income (Form 1040 line 43, notordinary income) typically runs about $76K, including $2K of recognized cap gains.
Let's suppose you've got a loss of $2K that you are debating about taking (for tax purposes).
By assumption, you've got $74K of ordinary income, and $2K of cap gains. The first $900 of those cap gains are taxed at 0% (because $74K of ordinary income, plus $900 of cap gains is still below the 15% bracket limit of $74,900).
The other $1100 of cap gains is getting taxed at 15%.
If you recognize a loss of $1100, you get to save that 15% on the last $1100 of gain. Relatively speaking, a nobrainer. But if you choose to recognize your whole potential loss of $2000, the extra $900 in losses is wasted. It reduces your cap gains to $0, but the last $900 weren't getting taxed anyway, so what's the point?
Instead of having $900 worth of losses "in the bank" that you could recognize January 2, for 2016 taxes, you've squandered the opportunity by using those losses to reduce a gain that wasn't being taxed.
Similar reasoning applies at the 39.6% bracket, where cap gains rates transition again - here from 18.3% to 22.3%. You may be better off deferring the loss if it takes you below $464,850 in taxable income. A problem we should all have. I mention it simply to illustrate that it is not the 0% tax on cap gains that creates this situation, but any transition in tax rates.
There are other situations where recognizing losses may be suboptimal. The ones I'm familiar with follow this general pattern of crossing a threshold amount (often some form of MAGI).
My specific situation is following:
I started MF investing only1-2 years ago and practically all my MF purchased this year experienced loses after dividend payments and year end capital gain distributions. To recognize the loses I would need to close almost all my positions. Is it really a good idea?
For examples my 2 best funds PRWCX and PONDX. Their prices now are the lowest in 2 years. That means all my contributions (including reinvestments from capital gains and dividends) to these funds during that time have loses. Do you recommend to sell them now with intension to purchase again in a month? (For closed to new investors PRWCX that probably means selling not 100%).
Do you want to be out of the market for a month? Or if you move that money to other funds for just a month, what are you hoping for?
If you're hoping for a gain, then when you sell (to move the money back to your original funds) you'll have short term gains that will be taxed at ordinary income tax (not cap gains) rates, which somewhat defeats the purpose of the move. If you're hoping for the fund not to go up, then what's the point? (Though you would be able to claim any loss.)
If (in the case of PONDX) you're just looking for income (i.e. monthly dividend, not appreciation), how much do you expect to get in a month vs. getting 1% in a bank account? That difference is approximately your opportunity cost, give or take the risk of PONDX or your replacement fund changing in value over the next month.
It may be better to think of moving the money to other funds for a year (to avoid the short term gain problems). If the market goes up in 2016 you'll still wind up recognizing gains, but at least they'll be long term. You have to weigh that tax cost against the losses you'll recognize now.
Looking at PRWCX, the shares that lost ~10% might be worth selling; I'm not sure I'd sell shares bought at the beginning of this year (~4% loss) - a lot of risk (in moving money around, possible short term taxes, etc.) for a small write off. So if you do a partial sale, these are the shares I'd keep (more below).
PONDX is different for a couple of reasons. One is that the monthly div reinvestments this year have had small losses (2-3%). So you may be looking at smaller losses per share. On the other hand, moving money to a different bond fund and back may be "cheaper" - as I described above, you generally don't expect much appreciation from bond funds.
Still, it's a volatile fund in a volatile category - a similar replacement fund could go up or down a percent in a month. If it goes up, that's better than keeping the money in cash. If it goes down (and tracks PONDX) then you would have lost the money anyway, and meanwhile you realize the loss for 2016 instead of later. Not that much volatility for bond funds, even funds like this, so the risks are less in moving money around.
If you're going to do a partial sale (as with PRWCX), then I'd suggest telling your broker (or TRP if you're invested directly) that you want the cost basis to be actual cost (specific shares), with the default method specific shares and the secondary method being highest first or tax utilization. You need to do that a day or two before the sale - the brokers I've been dealing with won't switch from average cost to actual cost (any other method) in less than a day.
This is important because you want to maximize the losses you're recognizing. If you use average cost, then all the shares you sell will be treated as having the same cost - which means you'll be averaging in the cost of even those shares that went up in value. On the other hand, if you use an actual cost method, then the cost of the shares sold will be the real costs, which for many shares will be above the average.
You notify the broker, and then when you sell the shares (or the next day) you notify the broker which shares you sold. It's easiest doing it online at the time of the sale. The system will let you pick the shares you're selling, and you just check off the most expensive ones until you've picked enough shares. Or if you told the broker to sell highest first, this will happen automatically for you. That will maximize the loss you recognize.
One other point: reinvested dividends will create wash sales if you don't sell your full holding. That means that some of the losses won't be counted now. You don't lose them, you just defer them. It's not terrible, and these days, the broker will do the calculation for you. If you purchased 10 shares this month (through reinvestment or separate purchase), then the losses on the oldest 10 shares will be deferred (not counted now).
The bottom line is: is taking this loss now of enough benefit to be worth these maneuvers? Taking the losses now and buying back means that you'll have bigger gains to pay later (since you're resetting the cost at a lower price).
I took a fair number of losses this year, but most years I don't even though they're available to me. And I did it with funds that were easy to replace or ones that I wanted to get out of. Swapping back into equity (or volatile bond) funds entails risk and possible tax costs. It's an easier decision when one has a long term replacement fund in mind.
No, no, leave well enough alone, unless you have huge gains and really need to reduce them to reduce taxes.