Avoiding Capital Gains Tax

[randomep]

 

For such a hardcore investment forum I am surprised no one has mentioned capital gains tax issues.

 

I am talking about people who invest in the tax-shelted accounts (IRA, RRSP, 401k) but who also have money leftover and must invest in a non tax sheltered account.  How does capital-gains tax affect your investment decision.

 

For my situation I generally if possible invest in a security by putting half in tax shelted and the other half in non-tax-sheltered. When the stock runs up and I want to sell I delay capital gains taxes and sell tax-sheltered account. But then if the stock runs up even more and I want to sell more I almost always harvest my capital losses to offset the capital gains. But if I don't have enough capital losses then i got a problem. I have found that I tend to hold a stock in that case, and often it has worked well because that stock runs up even more. So this situation has caused me to be a more patient investor. But what if I really know that the stock is gaining less than my (opportunity) cost of capital? What would you do in a similar situation? Note here I am mostly talking about long stocks, no shorts, no options. But tell me if you use them too.

 

I have heard lots of talk about people should avoid taxes but don't say how exactly. One exception is I heard some articles that mention in a survey of rich people, the survey found the rich people buy a large number of holdings, this way when they want to sell they have much more chances of finding offsetting capital gains. But that just delays the inevitable.

 

 

 

thanks

[bz1516]

I use the tax optimization option at IB.  it works so well you have to watch that you don't rack up too many realized losses while building up a huge potential tax liability in unrealized losses over several years.

[randomep]

I use the tax optimization option at IB.  it works so well you have to watch that you don't rack up too many realized losses while building up a huge potential tax liability in unrealized losses over several years.

 

huh? I understood either of the two sentences you said. What is tax optimization?

[Uccmal]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

[Rainforesthiker]

The first obvious tactic is in the US to hold your positions for greater than a year to obtain long terms capital gains treatment.

Beyond that, when you are considering selling a current position in which you have a large unrealized gain, your opportunity cost analysis has to consider that any new opportunity must not be just a little better than holding on to your current position, it must be a good bit better.  For example, I and many on this board will have large unrealized gains in stocks such as BAC and AIG.  There will likely come a time in a few years when these stocks are trading at 1.5x or more of book value, i.e., when they have become somewhat fairly priced.  Then I will be faced with a decision of whether to sell part or all of these positions to buy something else.  Assuming no unrealized losses when I sell, after I pay capital gains tax I am just left with roughly 75% of my capital to invest in the new opportunity.  Thus I have to believe that my 75% invested in the new position will do better than the 100% invested in the current position.  Thus any new opportunities have to be very good.  One thing I have considered is that, if BAC and AIG are paying good dividends, I may hold on to most or all of these, and use the amount invested as "dry powder" for future purchases using my margin account.  In other words, I may use my BAC and AIG holdings as collateral for purchases on margin.  If BAC and AIG get overvalued IMO, that will of course make the sell decision easier.  I generally don't use or even consider fancy options strategies for dealing with tax issues - I need to reserve all of my brain cells just to try to make smart investments :).  I know this is all very basic and obvious - but I hope this helps.

[randomep]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

 

Great points you made!

 

Firstly, I never thought RRSPs (and IRAs) were not tax efficient! I guess you are talking about a lump sum payment at 71yrs old? BTW I have both RRSP and IRAs

 

I'll read the BAC thread. But right now it seems like I just have to bite the bullet and pay the tax.

 

 

[matts]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

 

I believe almost all investments in RRSP are also eligible for TFSA if it is set up at a broker.  Not saying you should buy US leaps in a tfsa, but you can.

 

What do people think about the attractiveness of a RRSP if you are planning to retire in another country? my marginal tax rate right now is 40%+ and if I ever become non-resident I can withdraw my whole rrsp with a one time 25% tax. I know the 25% will also apply to any growth but it still seems like a good idea to me.

 

 

[EliG]

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry.

 

I disagree.

 

I'm in the 43% marginal bracket. Dear wife is in the 35%. We get a tax deduction on the RRSP contributions. Our marginal rates on withdrawals will be lower than our current rates. The difference in the marginal rates isn't the only benefit. A few decades of tax free compounding is worth a lot.

 

Here's another way to look at it: An RRSP is a leveraged investment where the government supplies an interest-free loan in the form of the tax deduction.

[randomep]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

 

I believe almost all investments in RRSP are also eligible for TFSA if it is set up at a broker.  Not saying you should buy US leaps in a tfsa, but you can.

 

What do people think about the attractiveness of a RRSP if you are planning to retire in another country? my marginal tax rate right now is 40%+ and if I ever become non-resident I can withdraw my whole rrsp with a one time 25% tax. I know the 25% will also apply to any growth but it still seems like a good idea to me.

 

That's what I thought too. But then I read that at 71yrs old you must either take a RRSP lump sum distribution or put it in a very safe investment vehicle like an annuity. So maybe he is refering to the lump sum distribution.

 

Also, if your RRSP is huge then maybe when your 55yrs old and say you are taking a year or more off to invest, you can just make an early withdrawal and just pay the penalty (if there one for RRSP, it is 10% for 401k) and the 10% is much less than what you would pay at 71.

 

 

[beerbaron]

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry.

 

I disagree.

 

I'm in the 43% marginal bracket. Dear wife is in the 35%. We get a tax deduction on the RRSP contributions. Our marginal rates on withdrawals will be lower than our current rates. The difference in the marginal rates isn't the only benefit. A few decades of tax free compounding is worth a lot.

 

Here's another way to look at it: An RRSP is a leveraged investment where the government supplies an interest-free loan in the form of the tax deduction.

 

Both of you are right but not for the right reasons.

 

1st- Taking into account your marginal tax rate will stay the same it is should be better to put money into RRSP than into a taxeable account. However, this might not true if:

• Your compound rate is very high
  
• You keep your positions for a long long time
  

Put the numbers in a spreadsheet and see for yourself with different scenarios.

 

2nd- In Canada when you retire, if you earn below 10 000$ (not sure exactly if it's 10 000$) amount your are entitled to a full Guaranteed Income Supplement (GIS). Passed the 10 000$ every 1$ of income reduces the GIS by 0.5$. So if you don't make any money your maximizing the benefits and if you earn a lot of income the benefit become irrelevant. Anything in between and your are deprived of free money from de government.

 

I remember doing the analisys and found out that I should stop  putting money into my RRSP at 42 years old if my expected return was going to be 6% per annum.

 

BeerBaron

[ERICOPOLY]

It's worthwhile to think the IRA strategy through to it's final conclusion. (if you are really successful compounding it )-- you wind up just racking up too much of an estate tax liability once you reach a certain point, even though it is meant to be "tax free" in the Roth.

 

I hit that point recently and then (after it fell back 10%) I decided that it would just go back up to that level soon enough and I may as well just stop trying to grow it myself.  So I turned it over to the pros.  I don't manage the Roth anymore (as of two weeks ago).  I still expect it to rack up this tax liability higher over time, but I think the management of it is now lower risk -- and since I can't keep as much of the gains, I think the risks should be lower as well.  Plus, this is lower stress for me -- a lot lower!

 

I can instead give money to my kids through a tax-advantaged indexing strategy (like a variable-annuity held in a Crummy trust).  Their eventual taxable gains on that will likely be lower than today's inheritance tax rates (which I assume to not go down with time).  However, I still haven't established any such trust for them.  Not sure if I will... just pointing out that from a tax standpoint, the Roth probably no longer has an advantage over the Crummy trust approach when you take into account the inheritance taxes and assume a low-risk indexing strategy.

 

 

[bizaro86]

 

That's what I thought too. But then I read that at 71yrs old you must either take a RRSP lump sum distribution or put it in a very safe investment vehicle like an annuity. So maybe he is refering to the lump sum distribution.

 

Also, if your RRSP is huge then maybe when your 55yrs old and say you are taking a year or more off to invest, you can just make an early withdrawal and just pay the penalty (if there one for RRSP, it is 10% for 401k) and the 10% is much less than what you would pay at 71.

 

At 71, you have 3 choices for an RRSP.

1) Take a lump sum distribution and pay tax on the full amount

2) Convert to an annuity

3) Convert to a RRIF. This is exactly like an RRSP, except that you must withdraw (and pay tax on) a certain amount of the balance every year. The amount varies by age, at 71 its 7.38% of your account value.

 

So if you have a 2,000,000 RRSP, you will have to take out 147,000 when you are 71. However, you can use a self directed RRIF, which has all the same allowable investments. If you want to hold 100% leaps in your 70s, you can.

 

The table of mandatory withdrawals is here: https://www.woodgundy.cibc.com/wg/reference-library/topics/retirement-planning/rrsp-maturity-options/rrif-minimal-withdrawal.html

[Yours Truly]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

 

Why can't you buy US leaps in your TFSA? I'm asking because I have BAC leaps in my TFSA with scotia itrade

[bookie71]

You might want to check as if your IRA goes directly (as in a beneficiary) they can take it out over their expected life. (Required Minimum Distribution, RMD). 

[bz1516]

I use the tax optimization option at IB.  it works so well you have to watch that you don't rack up too many realized losses while building up a huge potential tax liability in unrealized losses over several years.

 

huh? I understood either of the two sentences you said. What is tax optimization?

 

Meant to say building up a huge potential tax liability with unrealized GAINS over several years.

 

IB has several different options for calculating capital gains (losses).  The tax optimization option automatically matches trades which reduce the tax liability to the maximum extent possible each year.  From my experience with it, worst case is you will postpone tax liability for a year or two.  Best case would be a lot longer depending on other factors.

 

Have no idea about Canadiian taxes  or if this is even available through IB Canada.

[Uccmal]

Hi Randomep,  This topic has been discussed extensively in and amongst other threads, BAC primarily.

 

I have bought a range of puts ( date and strike) against my BAC leaps to protect my capital gains without taking the actual gain.  They are mostly catastrophe insurance, ie. low strike relative to the date bought.  I also use fairly short time frames on the puts.  The intent is for them to go to zero when I buy them. 

 

I bought some AIg puts over the christmas season rather than taking gains at the end of the year to push it off for a year.  I actually sold these at a small gain but that's okay.  I converted some AIG leaps to common in the new year before they expired pushing off the tax man. 

 

I trade within my RRSP.  The problem there is that we cant hold options on US stocks so it only makes a little difference. 

 

To avoid the tax man long term I have stopped contributing to my RRSP.  As it is, with a 15% return over the next 20 years I will have nearly 3 million, which will become fully taxable income at that time.  This is the result of the experiences of retirees who are paying alot of taxes.  Granitepost on this board first pointed this out to me.  RRSPs are a marketing ploy of the investment industry. 

 

The TFSA is another matter.  I have maxed contributions in this account.  I just wish I could buy Leaps in it.  But its purpose is as a savings vehicle, not a gambling tool. 

 

I use leverage judiciously in my margin accounts.  Normally less than 10% debt to debt + equity.  The interest costs, such as they are, are tax deductible.  I have a few stocks ready to dump to clear the leverage, if need be. 

 

I am basically self taught at most of this stuff.  I do my own taxes each year from the ground up, looking at sets of transactions.  Its tedious but very valuable to see what worked and what didn't work.

 

al

 

Why can't you buy US leaps in your TFSA? I'm asking because I have BAC leaps in my TFSA with scotia itrade

 

Seems I need to talk with TD about this.  Right now the account is set up to block me. 

[JBird]

I hit that point recently and then (after it fell back 10%) I decided that it would just go back up to that level soon enough and I may as well just stop trying to grow it myself.  So I turned it over to the pros.  I don't manage the Roth anymore (as of two weeks ago).

 

Whoa. Who did you choose to manage your Roth?

[ERICOPOLY]

I hit that point recently and then (after it fell back 10%) I decided that it would just go back up to that level soon enough and I may as well just stop trying to grow it myself.  So I turned it over to the pros.  I don't manage the Roth anymore (as of two weeks ago).

 

Whoa. Who did you choose to manage your Roth?

 

Roughly 30% with Sanjeev&Alnesh (MPIC).  The rest I decline to say.

[jeffmori7]

I hit that point recently and then (after it fell back 10%) I decided that it would just go back up to that level soon enough and I may as well just stop trying to grow it myself.  So I turned it over to the pros.  I don't manage the Roth anymore (as of two weeks ago).

 

Whoa. Who did you choose to manage your Roth?

 

Roughly 30% with Sanjeev&Alnesh (MPIC).  The rest I decline to say.

 

Congratulations to Sanjeev on this one!