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"I Hate Capital Gains Taxes" – Except When I Don't (Guest Post)

Posted by Michael Kitces on Thursday, June 9th, 11:54 am, 2011 in Taxes

When it comes to my personal taxes I am a chronic late filer.  In my own defense, it is usually because some partnership or another could not get me my K-1’s by the deadline so I go ahead and file the extension.  Or maybe it’s because the pain of actually seeing my tax bill is too great and I find a way to defer that decidedly unpleasurable experience to a later date.  This year I had a large tax liability associated with capital gains in my managed accounts, and since 100% of my money is invested in the Pinnacle DMG portfolio I couldn’t help but think of other Pinnacle clients in the same boat.  Since cutting a check to the IRS has the remarkable ability to focus my thinking about tax planning, I thought I would share a few of the thoughts that crossed my mind at the time.

(Editor's Note: This post was written by guest blogger Ken Solow, CFP, Chief Investment Officer and Founding Partner of Pinnacle Advisory Group, author of the book "Buy and Hold is Dead (Again)" and a blogger for Echoes From The Pit {which originally published this post}.)

While I was licking my psychological wounds I considered the fact that paying capital gains taxes is a negative experience tied to the pleasurable experience of making money on my investments.  If I lose money on my investments it is a very tax efficient strategy….I owe no tax for losing money.  Since Pinnacle Advisory Group usually uses my investment losses to offset capital gains, paying capital gains taxes typically means that I made some money somewhere in my portfolio.   That’s a good thing.  I could pay absolutely no taxes if I lose money or if I invest in securities that appreciate in value but don’t distribute any dividends or capital gains.  Of course, even if I don’t pay taxes today I will eventually have to pay the taxes later if I want to sell the appreciated securities in order to spend the proceeds, so this whole capital gains tax issue is all about the present value of paying taxes today or deferring the tax bill to a later date.  Interestingly, the value of deferring taxes isn’t nearly as great as you might think, especially when one of the alternatives is to not sell the security only to have it fall in value at a later date which is great tax planning, but tends to not be so good when it comes to getting wealthy.

The whole problem gets worse when there are no tax losses to use in order to offset capital gains in the portfolio.  In other words, you made too much money, to consistently, across all of the securities that you own, so that we can’t find any losers to offset your gains.  Many Pinnacle clients are in this predicament at the moment after a blazing two-year bull market.  Now that we may be near the market peak Pinnacle analysts are beginning to take profits and move to lower volatility securities.  This of course means more capital gains taxes.  If we owned the securities for less than a year, it means short-term capital gains which are even more disturbing come tax time.  

So…repeat after me….I don’t mind paying capital gains taxes if the alternative is losing my money in a bear market….I don’t mind paying capital gains taxes if the alternative is losing my money in a bear market….I don’t…..

Michael E. Kitces

I write about financial planning strategies and practice management ideas, and have created several businesses to help people implement them.

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