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Financial Planning / Tax Strategies
|Subject: Re: Tax loss harvesting possible with MLPs? REIT||Date: 8/6/2013 2:45 PM|
|Author: ptheland||Number: 118982 of 122105|
First, a little pet peeve of mine. Then the direct answer to your questions.
I don't like the idea of "tax loss harvesting". It makes no sense. The investment is either performing as you expected or it's not. If it's not, sell it.
When you bought the security, you should have had some idea of why you bought it. You bought it because it was undervalued or because it provided a good income stream or because it triggered some mechanical buy signal or because any number of good reasons to buy.
Likewise, there are good reasons to sell a stock. Perhaps it's business outlook changed and its future prospects aren't as good as you thought when you bought. Or perhaps the dividend got cut. Or perhaps some mechanical sell signal triggered. Or perhaps your analysis at the time you bought it was flawed. (That's a nice way of saying you made a mistake buying it.) Or perhaps you need the funds for some other purchase (which could be anything from a better investment to a vacation on the Riviera).
Noticeably absent from the list of good reasons to sell is because the investment went down. If it's still a good investment - that is, if it still fit the reason you purchased it in the first place - then there's no reason to sell.
A very common reason to buy a stock is because you think it's going to go up in value over some period of time. The problem is that you can't reliably predict EXACTLY when it's going to go up, particularly if you expect it to go up over the course of several months to several years. You may get a very significant portion of that increase in a very short time - as little as a couple of weeks.
If you sell to "harvest" some tax losses, you'll need to stay out of the investment for 30 days. I'll explain why in a moment. That could easily be long enough to miss out on a lot of gain. And if you do manage to repurchase the security near your selling price, you'll just pay additional taxes later when you do sell the next time. (Yes, there's the time value to money to consider, but that requires some detailed analysis to find out how much you are really saving in taxes now AND how much more you'll pay in taxes in the future, along with a realistic estimate of what you can earn on that tax deferral in the interim.)
So, with the rant out of the way, let's address your questions.
From what I've read, tax-loss harvesting does not work with MLPs. One person online suggested it can actually accelerate taxation. Is this correct in most scenarios in which one would sell MLPs that are down?
First off, partnerships are not like stocks in any way. With a partnership, you report your share of the partnership's income or loss every year - even if that income is not distributed to you. The distributions from a partnership are generally not taxable income - they are a return of your capital investment. So you figure your gain or loss on a partnership very differently from a stock.
Your basis in a partnership investment goes up and down each year. You start with your original purchase, add in any income the partnership passed through to you, and you deduct any losses or deductions passed through along with any distributions from the partnership. (Plus a whole boatload of other potential adjustments which I'm glossing over to keep things simple.) This is your adjusted basis in the partnership. When you sell a partnership interest, you do not look at the original purchase to determine your gain or loss, you look at this adjusted basis.
You also have to include your share of the partnership's income and/or losses through the day you sell. You won't know those amounts unless you've been following the partnership's reporting to you quite carefully, and even then all you'll be able to do is to make an intelligent estimate. You'll have to wait until you get your K-1 to know exactly.
Finally, there are a multitude of other things that can happen inside the partnership that can affect your gain or loss on the sale of the partnership interest. Generally, these are things that will convert what looks like a capital gain into ordinary income, causing you to lose the benefit of the lower tax rates on long term capital gains. They can also affect your ability to use capital losses.
In short, there is no way to generalize what selling an MLP will do to your taxes.
However, given the tax nature of a partnership, most business organized as a MLP will do so because they generate a lot of cash but not a lot of taxable income. If you've been receiving nice big checks from the MLP each year but not a lot of income to report, your adjusted basis in the partnership has probably gone down, and you will not have as much of a loss as you might think.
I am wondering if REITs are also bad candidates for tax-loss harvesting. I'm guessing that's the case: it seems too easy to come up with a systematic method to harvest losses after distribution.
REITs are a different beast. They are much closer to common stocks than to partnerships. A REIT is required to distribute most (I think it's at least 90%, but don't quote me on that figure) of it's taxable income each year to it's shareholders. In return, the REIT doesn't have to pay taxes on the earnings it distributes, but the shareholders get ordinary income instead of qualified dividends.
In a REIT, your basis isn't adjusting each year. It generally stays put unless the REIT makes a distribution that is a return of capital. So it's much easier to do tax loss harvesting with a REIT than with an MLP.
But if you have a regular stock that distributes qualified dividends, could you collect the dividend, sell the security at a loss, keep the dividend, and enjoy some tax advantages? Or are dividend distributions calculated into this, limiting your usable "loss"?
Perhaps, and No.
With ordinary common stock the dividends generally have no effect on your basis. So you can collect your dividends without worrying about any changes to the basis in your stock. The only dividends which would affect your basis are liquidating dividends. And those are fairly rare in common stocks.
One more thing to keep in mind is the Wash Sale rules. If you sell a security at a loss and then repurchase the security 30 days before or after the sale, you have a wash sale. With a wash sale, you cannot deduct the loss. Instead you defer the loss by adding the loss in to the cost of the replacement security.
This makes tax loss harvesting a bit more difficult, as you have to stay out of the stock (or MLP or REIT or whatever) for 30 days.
Of course, all of this is for the benefit of lurkers, because you thoroughly researched your investment - including how it would be taxed - before you purchased it. Right?
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