@mcat2 ,
Perhaps this Kitces article will help you PLAN ahead for your house/rental property:
On the topic of tax treatment of various sources of income:
Note that for simplicity of comparison, I am ignoring the 3.8% surtax on Net Investment Income for the purpose of this discussion and the implications of the AMT.
Am I correct in understanding that a 15% tax rate is imposed on ALL Qualified Dividend Income (QDI) and a top rate of 20% is imposed on Long Term Capital Gains (LTCG) for taxpayers above the 15% tax bracket.
The general conclusion I am drawing from this is that, during retirement, it is better to receive QDI than to realize LTCG if a taxpayer is above the 15% tax bracket during retirement.
Am I correct?
Excellent article, @AttorneyMother! Lots of food for thought. Sounds like another case of when itâs important to touch base with attorney or CPA before making firm plans.
Did anyone watch Tom Brokaw last night on Dateline NBC? It was a very good view of how multiple myeloma (cancer of the plasma cells in the bone marrow) has changed his life. He made a mistake in Montana and went to fish in a remote area with friends - way overdoing things considering he had been trying to minimize the back pain he had. Story was nicely done IMHO. He talked about how cancer is like a veil that changes how you see life. As a cancer survivor myself, I understand.
Some donât have to be as concerned about insurance/doctors/medical facilities with travel or home relocation. However it is always good to evaluate, because one doesnât know when medical situations interlope.
@AttorneyMother, as you phrase it, I have to agree. However, the timing of CG for all practical purposes is in your control, and the estate planning aspects are considerable.
Thank you, @HImom , planning ahead is a luxury that people forget they may have and often neglect to use. Itâs only recently that I have become more aware of it myself, thanks to this thread.
@IxnayBob, I pose the question largely to understand why retirees prefer dividend-paying stocks and whether I should fret too much if mutual funds are throwing off QDI.
As I see it then, if the mutual funds are already throwing off QDI, it is not disadvantageous (except in the short-term tax inefficiency, but that is not in the analysis) and allows one to postpone realization of LTCG as a source of retirement funding (and for estate planning).
@notrichenough , can you please take a quick look at Post 6321? Thank you.
My SisIL was in hospice and final days. When we visited, we gently asked her if she was interested and willing to have estate attorney come to her home and make sure things went where she wanted them (and save 6 figures of her estate). She consented and the attorney came to her house on Friday, returned on Monday to execute docs with her. Beloved SIL died on Tuesday, but working with the attorney, she was happy to leave more money with her beneficiaries instead of probate fees.
I donât think you are correct. LTCG and QDI are taxed at the same rates at the same income levels. From Pub. 17:
http://www.irs.gov/publications/p17/ch08.html#en_US_2014_publink1000171584
And the chart here:
http://www.irs.gov/publications/p17/ch16.html#en_US_2014_publink1000172517
This is the bracket I was focusing on regarding taxation of QDI v. LTCG:
Are you saying that taxation of LTCG is similarly stepped at 15%, then goes up to 20% at the 39.6% bracket? If thatâs the case, then treatment of QDI and LTCG are the same.
@AttorneyMother, yes, that is what I am saying. They are treated the same.
Where did you see otherwise?
Hereâs the response from my tax friend:
So you are correct, NRE. Thanks.
So, generally, if one can time/postpone LTCG, itâs better to do so if incurring LTCG pushes you into the top bracket (not to mention that NII at that level incurs the 3.8% surtax).
I think the answer to this is that retirees prefer a steady income vs. a pile of money in the bank. Especially if getting that pile of money will cost you and your heirs a pile of taxes.
Plus it is a lot of work to find something to reinvest that pile in. With a good collection of dividend stocks, you can just put it largely on autopilot, and get both income and asset growth.
I think retirees, and many others, prefer dividend-paying stocks because it plays into the (old-fashioned) desire to ânot touch the principal.â Itâs a form of mental accounting that has a fundamental flaw, namely that if everything else is equal, the share price will go down by the amount of the dividend. TNSTAAFL (thereâs no such thing as a free lunch).
I only own one stock voluntarily outside of our indexed funds, Berkshire Hathaway. It has done very nicely for us, and the color of its capital gains is precisely the same as the green of its (non-existent) dividends.
People also get comfort from âsteadily increasing dividends,â believe that it is a reflection of a successful company. I worked with some accountants years ago who managed the profitability of a company, and âmanagedâ in this context is actually a dirty word.
If a steady payout is what you need, there are funds that specialize in precisely that, but selecting a stock on that basis is the tail wagging the dog, IMO.
I believe that your supposition is correct. Blue-chip dividend-paying stocks used to be referred to as âwidows and orphansâ (apologies to both) securities for precisely this reason. The presumption was that corporate âmanagersâ can take their equity investments, earn a return (better than I could with the same pot of money) and share the profits via quarterly dividends. Corporate accounting prohibits the payment of dividends if there are no earnings.
Today, with the emphasis on capital growth, corporations that do not pay dividends, but which have large bundles of idle cash, are pressured to do stock buybacks. To my thinking, itâs the same thing, just in a different guise. The difference is that dividends provide a âreturnâ to stockholders without them having to relinquish their ownership in the business and then having to make another investment decision.
That said, fund managers are supposed to take over this function. But there are high-dividend mutual funds that exist for this purpose and tax-efficient funds that minimize dividends.
You do see the irony that Warren Buffet, while never paying dividends on Berkshire Hathaway (because of his buy-and-hold approach and preference for capital appreciation), loves dividend paying stocks:
I believe his practice (very generally) rests on the trust he placed on the ability of the managers of his portfolio companies to earn a return on his capital.
This happens every earnings period. Period. With the emphasis on earnings per share and management of expectations, and how both now cause price ticks in heavily-followed stocks, it happens.
I disagree. I think LTCG is always a better way to get income. If you need $100K pre-tax, you can sell appreciated shares. If the shares appreciated 100%, your taxable income would be $50K not $100K as would be if it all comes from dividends.
@iglooo , I agree with your scenario, which involves a return of basis. However, I was referring to taxable income that was strictly either QDI or LTCG (presuming that the return of basis has already happened). The basis was already my money to begin with.
I was trying to figure out if there is a different / more favorable treatment of QDI over LTCG within the same tax brackets.
I do agree that selling appreciated assets to realize spendable money is the more preferable route in that one only pays tax on the appreciation, but tax is payable on all QDI.
Thanks for explaining the tax issues. Since our house has become a rental property less than 2 years ago and one of us actually lived there before that, the following case could be similar to ours â assuming that we actually sell the house within a year: (the exclusion is only $250,000 instead of $500,000 because only one of us lives there.)
âIn the case of properties that have been converted from a primary residence into rental real estate, the key planning issue is to recognize that there is a limited time window when a property can be rental real estate but still be eligible for the Section 121 exclusion â eventually, the property is rental real estate so long, the owner will no longer meet the 2-of-5 use-as-a-primary-residence test. For instance, in the earlier Example 3, Donna can only rent the property for up to 3 years after living there as a primary residence, before she can sell it and claim the Section 121 exclusion (or risk moving beyond the 2-of-5 years time window).â
An alternative is for both of us to move back there and live there for 5 years. Because we were living there much longer than 10 years before we rented it out, we have many qualified years. We may not need to pay much capital gain taxes even if we need to pay some in the end.
mcat, I think you get $500k exempt if you file as a couple. I donât know if the IRS check to see if 2 people are living there.
I agree with DrGoogle, itâs if you file jointly, I would think.
Edit to add, I really donât know the rule, Iâm just taking a guess at what would be logical. However, who really understands IRS logic? Not even they understand it, so if there is uncertainty or a nebulous rule, I think you should file in your own favor.