In what order should I sell tax lots during rebalancing?

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anonymoustycoon
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Joined: Thu May 31, 2018 9:54 pm

In what order should I sell tax lots during rebalancing?

Post by anonymoustycoon »

Say I own an ETF whose asset class is overrepresented in my portfolio. I want to sell some of its shares to bring my portfolio closer to my desired asset allocation. Say I purchased the ETF in 4 tax lots, A, B, C and D, with cost bases of $80, $90, $110 and $120 respectively. Say the ETF is currently trading at $100. (Assume A and B have been held longer than a year and are therefore taxed at the long-term rate. Edit: Assume that C and D have both been held longer than 30 days, so there are no wash sale complications.) Suppose I intend to keep a position in this ETF long-term.

In what order should I sell these tax lots to maximize long-term after-tax portfolio value?

I hope there's enough information here to answer the question. I have an answer and I'd like to know if the reasoning is sound. My answer: sell in this order: C, D, B, A. My reasoning: Sell losses first to avoid paying taxes on the gains for A and B today; these losses can be used for tax loss harvesting. (So that means C and D should be sold before B and A.) Sell C before D because that will result in the lowest taxable gains when you sell at the future (presumably higher) price. Then sell B before A to minimize taxable gains today. So the final order is C, D, B, A.
Last edited by anonymoustycoon on Sat Jul 07, 2018 8:13 pm, edited 1 time in total.
drk
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Re: In what order should I sell tax lots during rebalancing?

Post by drk »

It depends on when you purchased lots C and D. If you bought lot D in the last 30 days, you'll have to sell it if you want to avoid a wash sale when selling C for a loss. Actually, I really value tax losses, so I would probably sell lot D before lot C regardless.
Topic Author
anonymoustycoon
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Joined: Thu May 31, 2018 9:54 pm

Re: In what order should I sell tax lots during rebalancing?

Post by anonymoustycoon »

drk wrote: Sat Jul 07, 2018 8:02 pm It depends on when you purchased lots C and D. If you bought lot D in the last 30 days, you'll have to sell it if you want to avoid a wash sale when selling C for a loss.
Good point. I'm going to update the question to state that C and D have been held longer than 30 days.
jacoavlu
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Re: In what order should I sell tax lots during rebalancing?

Post by jacoavlu »

Depends on your tax situation now, and in the future.

If you’re at a high marginal rate now you may want to take a short term loss to offset up to $3,000 of ordinary income.

If you have low taxable income now you may want to harvest gains now when you pay no capital gains tax.

If you already have harvested short term gains elsewhere this tax year you may want to harvest losses to offset those gains which are taxed at your ordinary income rate.
Topic Author
anonymoustycoon
Posts: 7
Joined: Thu May 31, 2018 9:54 pm

Re: In what order should I sell tax lots during rebalancing?

Post by anonymoustycoon »

jacoavlu wrote: Sat Jul 07, 2018 9:34 pm Depends on your tax situation now, and in the future.
Thanks, these are important variables that I didn't consider (i.e. current vs. future tax rates and the gains already realized this tax year). So I guess the question is too open-ended to have a specific answer that always works for everyone.
ivk5
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Re: In what order should I sell tax lots during rebalancing?

Post by ivk5 »

You might research Tax Loss Harvesting and Tax Gain Harvesting.
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grabiner
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Re: In what order should I sell tax lots during rebalancing?

Post by grabiner »

If you are selling for a loss, you should sell for the largest loss; it doesn't matter much whether a loss is short-term or long-term. (Short-term losses are better if you have both short-term and long-term gains in the same year, and your gains exceed your losses.)

If you are selling for a gain, but have carryover losses to offset the gain, it doesn't matter much whether the gain is short-term or long-term; minimize the gain.

If you are selling for a gain, and the gain will be taxed because you don't have losses to offset, it's usually better to take long-term gains rather than short-term gains, unless the short-term gains are very small. If you take a gain as short-term, you pay tax at a higher rate than necessary.

One other tax note: if you received a significant dividend from a lot, you may want to wait until you have held that lot 61 days, or else the dividend on the shares in that lot becomes non-qualified.

In your example here, you should sell lots C and D because you have a loss worth harvesting. If this leaves you underweighted, either buy a similar ETF or buy back into this ETF 31 days later. If the ETF rises to $110 or close to that, you should sell D, but not sell C unless you need to sell it to reach the correct allocation.
Wiki David Grabiner
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