Sometimes you need to try again. Two weeks ago, C.E. of Dallas asked, "When is the best time to sell a fund? Should we sell before the end of this year? Or wait until the first of next year? I am concerned about the hit we might take tax-wise.
"That's a knotty question.", I answered, suggesting a sale before the fund made a year end capital gains distribution.
But given the kind of year we're having and the massive run-up stock funds had in 1995, that wasn't enough of an answer… so bear with me while we sort out the tax consequences of different sales at different times.
Suppose you bought a fund for $10 a share in early 1996, knowing that the fund portfolio was carrying $3 a share in unrealized capital gains that it could realize and distribute at any time. Suppose also that the shares rose in value to $11 a share by November and that the portfolio manager decides to clean house and realize $3 a share in gains before year-end, making a mid- December distribution. Should you sell in November, before the distribution? Should you sell in December, after the distribution? Or should you sell in January?
All three create different tax liabilities:
- (1) If you sell in November, your capital gains tax liability will be based on the difference between your cost and the sale price, $1 a share. If you reinvest immediately, you could "buy a dividend" because you could receive a December capital gains distribution from the new fund. It's size would depend on the gains and turnover of the fund.
- (2) If you sell in late December, after the capital gains distribution, you will have a $3 capital gains distribution but you will sell your post-distribution shares for $8 a share, realizing a loss of $2 a share. This will give you an accounting headache but the net gain will still be about $1 a share. Waiting until January 1 to reinvest, you would probably avoid a capital gains distribution from the new fund.
- (3) If you sell in January, after the capital gains distribution in December, you will have a $3 capital gains distribution in 1996, followed by a $2 a share capital loss for your 1997 tax return. This means you'll pay extra taxes by April, 1997 but may not be able to use the $2 tax loss unless you have other gains to offset in 1997.
Of those options, selling in January is the least attractive because it presents the largest immediate tax bill and the greatest future uncertainty. The "cleanest" option would be to sell before the December capital gains distribution and hold cash until January, escaping a possible distribution from the second fund.
Yes, it's complicated. But it's only a problem in direct proportion to having made a mountain of money in the last two years. So don't complain.
You can also bet, looking at the current market, that a lot of very important decisions are going to be made in the next month or so.
Q. I have a reasonably diversified portfolio including 500 shares each of Procter & Gamble (PG), Conagra (CAG), Protective Life (PL), and Tommy Hilfiger (TOM). Each security has a tax basis of about 50% of current market. I also have a smaller number of shares in AT&T and the Baby Bells which were distributed from a testamentary trust with a near zero basis. I would like to update my portfolio with some new investments, but am concerned about the capital gains impact coupled with the current level of the market, i.e. do not want to get a double whammy from capital gains followed by a market correction which diminishes the reinvested proceeds. What is your strategy for managing reinvestment goals with capital gains?
I am basically a "buy and hold" type, but believe in actively managing investments. I know about covered shorts as a temporary measure-what about bartering? There also seems to be an associated problem of stop-loss limit orders on highly appreciated stocks which could lead to an unexpected capital gains liability as a consequence of a sudden downturn.
---A.L., Dallas, TX
A. The best capital gains strategy may be to vote Republican and do it as often as possible, preferably up to Chicago standards. Populist rhetoric notwithstanding, there is such a mother lode of potential tax revenue in unrealized capital gains that politicians of both ilk are going to have to get serious about reducing the capital gains tax rate and unleashing the revenue. Reducing the rate to 14 percent, as proposed, would do a lot to reduce your inhibitions about selling.
If you are relatively young, i.e. have a life expectancy of 10 years or more, you need to bite the bullet and sell the stocks you "over-own". Otherwise, you will be investment paralyzed for life.
Older folks can hold on and gamble they will die and take the capital gains tax liability with them. ( Unrealized capital gains are not tax liabilities in an estate because the cost basis is marked up to the value at death.) This will spite the tax man and, as many wags have observed, is the only remaining incentive any of us have to die.
File Name: 961024TH
Dallas Morning News file date: 10/24/96---THU
Universal Press Syndicate file date: same
©
Dallas Morning News, Universal Press Syndicate, 1996
