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I recently read some tax savings tips that stated:

Get the IRS to absorb part of the sales load on a mutual fund. Do this by buying shares in a money fund offered by a family of funds. After three months or more, transfer out of the money fund and into one of the other fund options (stocks, bonds, etc.). the sales load will produce a loss on the sale of the money fund shares which you can deduct or use to shelter other gains from tax.

This just does not sound correct to me. Can someone confirm or deny the information? It seems to me that there would be not tax impact for the sale of the money fund and there would be a reduction (by the amount of the sales load) in the cost of the other fund purchased but still no tax impact at that time. If it matters this was from some years ago, perhaps about 1998 if there may have been different tax provisions at that time.

Bob
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Get the IRS to absorb part of the sales load on a mutual fund. Do this by buying shares in a money fund offered by a family of funds. After three months or more, transfer out of the money fund and into one of the other fund options (stocks, bonds, etc.). the sales load will produce a loss on the sale of the money fund shares which you can deduct or use to shelter other gains from tax.

This just does not sound correct to me


From a tax law aspect I don't see a problem, assuming that you're not reinvesting in another fund that is substantially the same as the one you just left.

From a dollars in the pocket perspective, if someone thinks this is a good idea, please call me. I have some beachfront property in Florida that you'd love.

"Best" case scenario, with numbers:

1. You follow this advice and put $100,000 in Fund A.

2. In time to "take advantage" of the back-end load, you get out of Fund A and invest in Fund B. You pay a $3,000 early redemption load, thus giving you a $3,000 short-term capital loss.

3. You have no other Schedule D transactions for the year, so your Schedule D bottom line is a $3,000 loss. Since you're in the 45% combined state and Federal bracket, this loss saves you $1,350 in taxes. WOW!

Before you blow the savings on champagne and caviar, count your change. Before you started this brilliant tax coup you had $100,000 in your pocket. You now have:

Original investment: $100,000
minus load: -$ 3,000
plus tax savings $ 1,350

Net in your pocket: $ 98,350

Hmmmm. Repeat this enough times and you could go broke. Check with me about my bridge that's also for sale.

Phil
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Do this by buying shares in a money fund offered by a family of funds. After three months or more, transfer out of the money fund and into one of the other fund options (stocks, bonds, etc.).

What is a money fund? In one fund family I was in until about May, their money market fund itself did not have any sales charges and it managed to keep its share price at $1.00, so liquidating it had zero tax impact!

I did recently sell all the funds in that fund family, the personal (taxable) accounts netting almost $21,000 of capital losses, which means I will have a 7-year tax break (using $3,000 of capital losses per year to offset ordinary income until all the capital losses are used up). The money I had in that load family in actively managed funds is now sitting in Vanguard index funds and a Vanguard tax-managed fund. After consulting with the IRS W-4 calculator and my tax preparer, I increased my W-4 allowances to compensate. Now I have more money to squander on investments! 8)

PS: I am having a hard time to convince a coworker to invest, now that he knows I have had a net $21,000 capital losses to show for the last 5 years of investing. 8)
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By the way, I have estimated that my losses would have been more like $1,000 instead of $20,900 if it weren't for the loads and high expense ratios.

Where can I buy that under-water beachfront property? 8)
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What is a money fund?

I assumed that it was a money market mutual fund, but to be sure I didn't misquote I put the exact wording into my post. I understand that a money market fund maintains a $1 NAV so I would think that any transaction out of the fund would not have a capital gain or loss. I further assumed that there were no loads associated with the money market fund but that there was a front end load on the new fund purchased. Under these conditions I don't believe there would be any tax impact and certainly the IRS was not absorbing any part of the sales load.

Phil,
Under your scenario, you apparently assumed there was a back end load on the money market fund and yes I can see how a capital loss might occur. But like you I still can't see a real advantage to the “system”.
Do you have any Arizona beach front property?

Bob
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Do you have any Arizona beach front property?

Not yet, but wait for the "Big One."

Phil
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Under your scenario, you apparently assumed there was a back end load on the money market fund and yes I can see how a capital loss might occur. But like you I still can't see a real advantage to the “system”.

I found that part confusing. If we're talking about a front-end load there's no tax impact until the new fund is sold, so what was all the bother with the money fund in the first place? Putting a back-end load on that fund was the only way I could come up with any kind of immediate tax effect. Of course, the author, given his acumen, my have been saying that loads reduce your gains and thus reduce your taxes. I believe that was the cover story of last month's "DUH" magazine.

I keep telling people, "If it reduces your taxes, it reduces the net amount of money in your pocket," but does anyone listen?

Phil
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Assuming the "money fund" portion of the advice was untrue or an error, would the following work for up-front load funds?:

You buy class A shares with a 5.75% load (eg like investor shares at American Funds) that have a NAV of $1. In order to account for the load, American Funds lists your purchase NAV as $1.061. At least that is how my statements came way back when I used to have some load funds. Assuming no change in the NAV (i.e. it's still at $1) if you exchange your shares later on in the same year (there is not an additional load on exchanges) you'll actaually show a loss of $5750, and get some of that back on your taxes, which you could then invest, thus decreasing the total after-tax effect of the load. Of course, then you have decreased your cost basis of the new shares relative to the old, and so will pay extra taxes in the future when you sell the shares you exchanged in to, right?

So it's choosing to take a loss today, vs. less gains in the future. Isn't it possible to come out ahead on an after-tax basis this way?
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So it's choosing to take a loss today, vs. less gains in the future. Isn't it possible to come out ahead on an after-tax basis this way?

I suppose one could torture enough numbers and assumptions to come up with something that would show that.

I'm of the KISS school. If I spend $5,000 to save $2,000 in taxes, I'm out $3,000 that could have been invested elsewhere. If I spend $5,000 to have a $5,000 lower basis in a share purchase, I'm still out $5,000 that could have been working elsewhere.

For the time being I'm going to stick with "There may be good reasons to pay a load, but tax savings isn't one of them."

Phil
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You buy class A shares with a 5.75% load (eg like investor shares at American Funds) that have a NAV of $1. In order to account for the load, American Funds lists your purchase NAV as $1.061. At least that is how my statements came way back when I used to have some load funds.

But with money market funds?

I had investments at OppenheimerFunds. There was no load on their money market funds, so if one purchased $10.61 of their "Cash Reserves", one paid $10.61 and would receive 10.61 shares of "Cash Reserves", NAV and offering price both at $1.00. Then if one later "exchanges" 10.61 shares of Cash Reserves for one of their stock funds with a NAV of $10.00, the offering price would be $10.61 (to account for the 5.75% load), so $10.61 would exit Cash Reserves, would buy 1 share of the Stock Fund at an offering price of $10.61, and just after the transaction oe would still have 1 share but at a NAV (share price) of $10.00.

This kept the tax impact of "Cash Reserves" at only the dividends paid, no capital gains nor capital losses for selling any shares of "Cash Reserves". But with that stock fund, if one purchased at $10.61 offering price, and the next day sold at $10.00 NAV, one would have the $0.61 of capital losses based on trading that stock fund.

So it's choosing to take a loss today, vs. less gains in the future. Isn't it possible to come out ahead on an after-tax basis this way?

I can think of specific exercises where this might be beneficial:

- One gets the loss now and benefit from the offset to other gains or income, and then in the new invetment (or reinvestment past the 30-day window), one could then hold the shares for over a year and, if they have appreciated, one can again get a tax advantage by donating them to a 501(c)(3) organization, so one again reaps the tax deduction for the fair market value of the shares at the time of the donation but don't have to pay capital gains on them. Or, one dies after enjoying the capital losses, the party that inerit the new shares will benefit from the stepped-up basis so, other than possibly estate taxes, one's heirs escape capital appreciation taxes on those shares for gains that occurred before the date of evaluation of the estate (typically the date you die, but the personal representative can pick the alternate date, which I think is six months from date of death, if that makes for a better overall tax sitiation).

- One wants to change one's investments. (My example is moving personal investments from OppenheimerFunds to Vanguard.) There is the advantage of selling at the market bottom and purchasing the desired investments because the capital losses, if there are no capital gains to offset them, will offset ordinary income (up to $3,000/yr until the capital losses are used up), which will save one's taxes at one's marginal income tax rate, and if the new investments get their returns primarily by appreciated share prices, if one holds for over a year before selling, if the capital losses had already been consumed, the gains would be taxed at the lower capital gains rates. If I can save taxes the next few years at 25% marginal income tax rates and after that pay taxes on long-term capital gains at only 15%, I have come out ahead of where I was. (And in my example, also benefitted by the expected higher total returns by being in funds that typically beat 80% of funds investing in similar investments.)

- Churning similar but not "substantially identicial" investments. This will have immediate tax benefits from today's capital losses that, if they exceed capital gains, can offset up to $3,000 of ordinary gains (e.g., at the 25% marginal income tax rate would save $750 in federal income taxes each year until the capital losses are used up) versus long-term capital gains one would potentially pay in the future which, hopefully, will be 15% of the gains (so $3,000 of long-term capital gains would have $450 of taxes due). It just may be worth it. However, I find it at odds with a simple Asset Allocation plan where one would be purchasing more of the under-represented fund, not selling off the fund that experienced the most losses after a year.

Normally, though, one invests to make money (and endure the taxes that go with it), not to maximize the capital losses (and thus reduce one's net worth). Where it makes sense to do so, it may be worth it to harvest tax losses; but that has to be kept secondary to one's investment plan--the goal should be to maximize one's assets and taxes are just one of the considerations, not to minimize taxes with maximizing one's assets being just one of the considerations. After all, I have yet to hear anyone seriously suggest that one quits one's job to reduce one's taxes, yet sometimes investment advice and mortgage advice comes across sounding equally rediculous. 8)
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Or, one dies after enjoying the capital losses

Where do I sign up?

Phil
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I'm of the KISS school. If I spend $5,000 to save $2,000 in taxes, I'm out $3,000 that could have been invested elsewhere. If I spend $5,000 to have a $5,000 lower basis in a share purchase, I'm still out $5,000 that could have been working elsewhere.

For the time being I'm going to stick with "There may be good reasons to pay a load, but tax savings isn't one of them."


Absolutely! I wouldn't think you would INTENTIONALLY pay a load in order to try to get some tax savings. But there ARE a few misguided people out there that have been convinced that paying nearly 6% for a load fund buys them a better fund. So once the payment of a load is assumed to be a given, then a sale for a loss "gets you back" a portion of that load. But I agree wholeheartedly that it would be idiotic to pay a load when you didn't have to simply to get some tax savings. That's stupid. :) Heck, give ME $5000, and I'll turn right around and give you $4500...MUCH better deal than the IRS!

No-load, tax-efficient, low turnover index funds...that's the way to go. ;)
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