Windfall and Capital Gains tax planning

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craftywiley
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Joined: Fri Jun 18, 2021 8:38 pm

Windfall and Capital Gains tax planning

Post by craftywiley »

I just had a windfall of about 500k of long term capitals gains - I
I will owe a bunch of that in taxes In April 2022 for the ‘21 return (and we’ll see what kind of rate based on what happens with the tax bill…!)

My question is about what to do with the anticipated amount I will owe (let’s say 150k) in meantime until next April.

As my horizon is long term, my thought is just to put all 500k into a long term target date fund. If the value goes down (which it might…PE ratios are high) I will have (short term) losses to write off against the gains and then be able to buy something else similar that isn’t a wash sale. In this case, I will pay “the market” instead of the government (and presumably then recover these losses in the long run)

If the value doesn’t go down, then I will not have missed out by being too conservative. So to some degree aren’t I “playing with house money” until the end of 2021?

But this approach seems to fly against convention and what financial advisors say. What is wrong with my math / logic?
Boatguy
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Re: Windfall and Capital Gains tax planning

Post by Boatguy »

If the rule of thumb is to not put short-term cash needs (the definition of short-term varies, but certainly cash needed within the next year) into the market, then I’m not sure of the wisdom of doing just that with the $150k. I know I wouldn’t, because I still look at a short-term capital loss as a loss nonetheless. You won’t be able to offset the capital gains that you just enjoyed with these losses — if they happen — because they occurred in different tax years. Just one conservative guy’s opinion!
tcw
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Re: Windfall and Capital Gains tax planning

Post by tcw »

I'm glad you posted this question, because I also recently received a windfall that's in the same ballpark as yours, and I've been trying to figure out how to prepare for the taxes.

For the sake of discussion, let's say my windfall is the same size as yours, at $500k. I put the amount to be taxed, $150k, in a bond index fund, and the rest in a stock index fund. I assume that the bond index fund will not change much in value. The idea is that, at tax time, if stocks go down, then I can just liquidate the bonds to pay taxes, so I won't be forced to sell stocks when they're low. If stocks stay the same or go up, then at tax time I can sell whatever mix of stocks and bonds that I feel comfortable with.

If you put it all in a target date fund, you won't have the choice of what proportion of stocks and bonds to liquidate, so if stocks happen to have tanked at tax time, you'll be forced to sell stocks when they're low.

In your case, a target date fund may have a lower bond allocation than 30%. Let's say it's 10%. If you make a portfolio with the same 90/10 allocation of stocks and bonds, but you put them in separate funds, then you get the same allocation as the target date fund, but have the ability to control what proportion you sell at tax time. So if stocks go down, you can sell all the bonds plus however much of the stocks are needed to cover the tax bill. If stocks go way up, you can sell just stocks, so that it your portfolio gets rebalanced toward the 90/10 ratio.

There well could be flaws in my reasoning, though. I'm not an expert at this stuff. I'd be interested to hear others' opinions about how to handle this.
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cchrissyy
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Re: Windfall and Capital Gains tax planning

Post by cchrissyy »

You would have to lose all 500 to wipe out the tax liability.

If the market falls say, half, at year end you harvest that loss and still have to come up with roughly half of your 150 tax bill.
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GMCZ71
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Re: Windfall and Capital Gains tax planning

Post by GMCZ71 »

craftywiley wrote: Fri Jun 18, 2021 8:54 pm

My question is about what to do with the anticipated amount I will owe (let’s say 150k) in meantime until next April.

I What is wrong with my math / logic?
If you miss a quarterly tax payment, the penalties and interest charges that can accrue depend on how much you make and how late you are.

The IRS typically docks a penalty of .5% of the tax owed following the due date. For each partial or full month that you don’t pay the tax in full on time, the percentage would increase. The penalty limit is 25% of the taxes owed.
John | * Friends and family and money | * What you recommend will have periods of underperformance. You will be blamed. | * You avoid the suspicion of "self-serving." by Taylor Larimore
lazynovice
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Re: Windfall and Capital Gains tax planning

Post by lazynovice »

GMCZ71 wrote: Sat Jun 19, 2021 7:37 am
craftywiley wrote: Fri Jun 18, 2021 8:54 pm

My question is about what to do with the anticipated amount I will owe (let’s say 150k) in meantime until next April.

I What is wrong with my math / logic?
If you miss a quarterly tax payment, the penalties and interest charges that can accrue depend on how much you make and how late you are.

The IRS typically docks a penalty of .5% of the tax owed following the due date. For each partial or full month that you don’t pay the tax in full on time, the percentage would increase. The penalty limit is 25% of the taxes owed.
As long as the poster meets the safe harbor by paying 110% of last year’s tax liability, there will be no penalty.
dharrythomas
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Re: Windfall and Capital Gains tax planning

Post by dharrythomas »

We were part of a de novo bank that sold out. I paid estimated taxes. It was less than $150K, but we moved everything to it’s ultimate destination (IRS, Vanguard, bank, family, church) as soon as it hit the bank account. May not be optimal but it prevents behavioral errors. For this timeframe, anything other than very short term debt is risky.
shess
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Re: Windfall and Capital Gains tax planning

Post by shess »

cchrissyy wrote: Sat Jun 19, 2021 12:17 am You would have to lose all 500 to wipe out the tax liability.

If the market falls say, half, at year end you harvest that loss and still have to come up with roughly half of your 150 tax bill.
But if you do this, you'd probably want to be really careful that you land the loss and the gain in the same tax year, otherwise you'll have to come up with the $150k to pay taxes for 2021, and you'll carry the big loss as an asset as your roll it forward looking for gains or $3k/year of income to offset it against. You can't roll a loss realized in 2022 to offset a gain realized in 2021.

[cchrissyy did say "at year end", I just felt it important to call that out rather than assume it was understood.]
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cchrissyy
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Location: SF bay area

Re: Windfall and Capital Gains tax planning

Post by cchrissyy »

indeed! thank you
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reader79
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Re: Windfall and Capital Gains tax planning

Post by reader79 »

If I were in your position, I would roll those gains into a Quality Opportunity Zone investment opportunity. Origin Investments is a highly regarded private real estate investment firm with $100k minimums.

Here is a short video they released, but they have longer videos explaining some benefits of QOZ investing on their site: https://youtu.be/5isYlHVJeo0
VTI: 50%, QQQM: 30%, VO: 10%, VB: 10%
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