Capital Gains complexity

Submitted by RonC on Fri, 2021-03-19 14:54

Not really an IRA issue but hope to learn how capital gains taxes will apply in this scenario.. I recently distributed my 401k to both IRAs and ESOP to NUA. I get that the stock has just been bought and the Cost Basis has been taxed at ordinary rate, and the balance (NUA) is already qualified/eligible for long-term CG rate. However this is where I could use some clarification.. Dividends and subsequent gains during the first year and beyond.. let’s assume that the CB was 5% and the subsequent gain is already 10%.. I’m pretty sure any DIV during first year is subject to ordinary income tax whether taken or re-invested (a taxable event). So if I sold stock during the first year, I’d pay LT CG on 95% and Short Term (ord inc tax) on the 10% gain (and DIV) ? In the 2nd year, would DIV be qualified as LT ? Will the gains during the 1st year be taxed as LT once held more than a year? If stocks always go up there will always be ST mix that has to be taken with LT ? Lastly, gain’s eligible for step-up in basis but what about reinvested DIV ? Thanx



Submitted by Alan - IRA critic on Fri, 2021-03-19 16:33

With respect to dividends paid at all times after distribution, if they are qualified dividends they are taxed at the lower LTcap gain rate. If not qualified, they are taxable as ordinary income. As for the stock sale in the first year, the additional 10% gain is taxed at the ST rate, if sold after 1 year additional gains would be treated as LT, same as the NUA per share. It does not matter when the gains were generated, just when you sell shares. Again, dividends are handled like any other stock dividends just as if they were not associated with NUA shares. If you are reinvesting dividends after the distribution, you probably should not be because now you will have shares acquired on several different date, so you will have to differentiate with respect to WHICH shares you are selling. Reinvestment also compounds any diversification issues you may have by holding too many of these shares. In other words, there was no short term mix for sales after one year of the original shares, but there will be now for the reinvested dividends. Unless you are going to sell all the shares in the next 6 months or so, I suggest you terminate the dividend reinvestments so simplify your Form 8949 reporting after shares are sold.

Submitted by RonC on Fri, 2021-03-19 17:46

I set DIV (& cap gains) to NOT reinvest and selected FIFO although that prob doesn’t matter if no new shares are to be puchased. Just to be crystal clear, as long as I wait 366 days, both DIV & Gains will be at LT rates. So I just have to “take a hit” on the first year’s DIV ?

Submitted by Alan - IRA critic on Fri, 2021-03-19 18:55

Yes, after 366 days, all gains on the original shares are taxed at LT rates. Before that time if you sell, any additional gains are taxed at ordinary income rates (ST gains). The dividends from day 1 are also qualified dividends if you meet the 60 day holding period for the shares for qualified dividends. The holding period starts 60 days prior to the ex div date and runs till 60 days after the ex dividend date, but you are treated as not having held the shares until they were distributed to your taxable brokerage account. This means that your first dividend may not be qualified because you sold too soon, but all subsequent dividends would be qualified because you would have met the holding requirement for them. Therefore, for your dividends to be qualified to be taxed at the LT cap gain rate, you re dealing with an entirely different holding period than for actual cap gains. Following is a link that explains qualified dividend holding periods.
Qualified Dividend Definition (investopedia.com)

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