Capital Gains and Qualified Dividends

The May 2019 update to MaxiFi implemented a major redesign of how we handle capital gains on taxable assets in the regular asset account and capital gains on bequests. In the past, we realized future capital gains as they were accrued, i.e. in the year they were earned and assessed capital gains on bequests. With that update, we now realize capital gains on a pro-rata basis when they are withdrawn from the regular asset account and we exempt death bequests from capital gains.

You set unrealized capital gains (i.e. previously accumulated long-term capital gains or losses) on your Regular Assets as of the end of last year through Settings and Assumptions > Taxes tab. Unrealized long-term capital gains are positive dollar amounts and carryover losses are negative dollar amounts.

On this screen, you can also set the percentage of future taxable Regular Asset income that our calculations should assume are long-term capital gains or qualified dividends. In the image above, the user is indicating that 20% of future earnings on regular assets will be taxable at the capital gains rate. The other 80% will thus be taxable as ordinary interest. The user is also indicating that $50,000 of the current balance in regular assets represents unrealized capital gains.

With this information, MaxiFi updates both unrealized capital gains (carryover losses if negative) and the Regular Asset balance at the end of the year based on the annual return. Positive returns that include capital gains increase unrealized capital gains or decrease carryover losses. Negative returns decrease unrealized capital gains or increase carryover losses. When MaxiFi generates a withdrawal from the Regular Asset account and there are unrealized gains, then the pro-rata share of capital gains realized in that withdrawal is determined based on the updated end of year balances and the amount of the withdrawal. Carryover losses are used to offset capital gains and to take up to a $3,000 loss per year. MaxiFi now passes bequests to heirs with no reduction due to capital gains taxation. That is, it now incorporates what's known as "step up in basis."

(The capital gains on real estate property are realized when you sell the property.)

There are four possible permutations as illustrated in the following examples.

In all cases, last year's (2018 in this example) Regular Asset Balance is $300,000, the percent of taxable Regular Assets income that are long term capital gains or qualified dividends is 80%, and the current-year withdrawal (2019 in this example) is $50,000.

1. 2018 Unrealized capital gains: $200,000 and 2019 Nominal Return: 3.5%.

  • First, Balances based only on 2019 returns:
    • Regular assets: $310,500 = $300,000 + 3.5% *$300,000.
    • Unrealized capital gains: $208,400 = $200,000 + 3.5% * $300,000 * 80%.
  • 2019 Capital gains:
    • Realized Capital Gains: $33,559 = $50,000 * ($208,400 / $310,500).
  • EOY 2019 balances:
    • Regular Assets: $260,500 = $310,500 - $50,000.
    • Unrealized Capital Gains: $174,841 = $208,400 - $33,559.

2. 2018 Unrealized Capital Gains: $200,000 and 2019 Nominal Return: - 3.5%.

  • First, Balances based only on 2019 returns:
    • Regular assets: $289,500 = $300,000 - 3.5% *$300,000.
    • Unrealized capital gains: $191,600 = $200,000 - 3.5% * $300,000 * 80%.
  • 2019 Capital gains:
    • Realized Capital Gains: $33,092 = $50,000 * ($191,600 / $289,500).
  • EOY 2019 balances:
    • Regular Assets: $239,500 = $289,500 - $50,000.
    • Unrealized Capital Gains: $158,508 = $191,600 - $33,092.

3. 2018 Carryover losses: -$200,000, i.e. negative gains and 2019 Nominal Return: 3.5%.

  • First, Balances based only on 2019 returns:
    • Regular assets: $310,500 = $300,000 + 3.5% *$300,000.
    • Unrealized capital gains: -$191,600 = -$200,000 + 3.5% * $300,000 * 80%.
  • 2019 Capital gains:
    • Realized Capital Gains: $30,853 = $50,000 *($191,600 / $310,500).
  • EOY 2019 balances:
    • Regular Assets: $260,500 = $310,500 - $50,000.
    • Unrealized Capital Gains: $160,747 = $191,600 - $30,853

4. 2018 Carryover losses: -$200,000, i.e. negative gains and 2019 Nominal Return: -3.5%.

  • First, Balances based only on 2019 returns:
    • Regular assets: $289,500 = $300,000 - 3.5% *$300,000.
    • Unrealized capital gains: -$208,400 = -$200,000 - 3.5% * $300,000 * 80%.
  • 2019 Capital gains:
    • Realized Capital Gains: $35,993 = $50,000 * ($208,400 / $289,500).
  • EOY 2019 balances:
    • Regular Assets: $239,500 = $289,500 - $50,000.
    • Unrealized Capital Gains: $172,407 = -$208,500 - $35,993.