Question

As of November 30, 2017 Ms. B had $12,000 capital losses and no capital gains. She owns 4,903 shares of GG stock with a $15 basis and a $45 FMV per share. Mrs. B plans to hold her stock for three more years before selling it and using the proceeds to buy a home. However, she could easily sell 400 shares to trigger a $12,000 capital gain and then immediately repurchase them. If Ms. B’s marginal income tax rate is 33.9%, she is subject to the Medicare contribution tax, and she uses a 4 percent discount rate to compute NOV, should she implement this strategy.

Answer 1

Issue:

Ms. B had $12,000 capital losses on Nov 30 2017.

Ms. B also has an option of selling 400 shares earning a capital gain of $12000 and repurchase them immediately.

Question: Ms B should implement the strategy or not?

Option 1:

Step 1:

As the Rule of wash sale is applied to realised losses only. The Capital Loss of $12000 can be reduced by $3000 each year for the immediate 4 years including current year. As a result, Average Gross Income (AGI) is reduced by the Deductions and results in tax savings.

  Amount of Annual Tax savings from above

Tax savings = Capital gain * Tax Rate

                    =$3000*33.9%

                    =$1017,

Annual Tax Savings is $1014 for each of 4 years (including current year)

Step 2:

Now NPV of the scheme at 4% discount rate

NPV =Annual tax savings *PVAF (present value of annuity factor)

        =$1017*1+$1017*2.775

        =$1017+$2822.2

        =$3839.2

Option 2:

Step 1:

Ms. B can also adopt strategy of selling G stock and capital loss of $12000 is to set off by capital gain of $12000 and would be taxed at 24% after 3 years.

Amount of annual savings from the above

Tax savings =Capital gain * Tax savings

                    =$12000*24%

                    =$2880.

Step 2:

Now NPV of the scheme at 4% discount rate

NPV =Annual tax savings *PVAF (present value of annuity factor)

        =$2880*0.889

        =$2560.3

Conclusion:

NPV of Option 1 is $3839.2

NPV of Option 2 is $2560.3

Hence, stock of GG must not be sold by Ms. B

Note: It is assumed that average tax rate after 3 years is taken as 24%

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