As I write this, the full Senate is considering the Tax Cuts and Jobs Act (TCJA). One provision in the Senate’s version of the TCJA impacts the treatment of capital gains. Specifically, the provision would eliminate your ability to specify which lot you sold if you purchased shares of the same security on more than one date. Here is the specific text from the legislation:
“Unless the Secretary permits the use of an average basis method for determining cost, in the case of the sale, exchange, or other disposition of a specified security [within the meaning of section 6045(g)(3)(B)], the basis (and holding period) of such security shall be determined on a first-in first-out basis.”
Things could change in the Senate or during the reconciliation process, if the bill gets Senate approval. (The House version of the TCJA does not contain this provision.) Still, since some AAII members have contacted me about the potential change, I thought it might be helpful to discuss the rules under current law and how the provision would alter them.
Under current law, you are required to specify which shares of a security you sold when calculating your capital gains and losses. An advantage of the specific-share identification method is the ability to manage your tax liabilities by picking shares with the most advantageous basis. (The basis is the value of the item at the time of acquisition or purchase.) Say you bought 100 shares of XYZ in January at $25 per share and 100 more shares after the stock jumped to $40 in April. The stock has since pulled back to $35, which is below your April purchase price but above what you paid in January. If you provide instructions to your broker BEFORE you place the trade, you can sell the lot of 100 shares purchased in April—instead of the lower-priced January lot—to realize a loss for tax purposes.
You can also opt to use the first-in first-out (FIFO) method, which would mean selling the January lot first. You might choose this method if you have an offsetting loss you can match against the gain. If you do not specify which lot to sell in advance, you must use FIFO when calculating your capital gains and losses. The provision in the Senate’s version of the TCJA would make FIFO the only option available to individual investors. In other words, you would no longer have the option of choosing (in the case of the example given) the January or April lot. Rather, you would be required to sell the January lot first. This would result in a capital gain being recognized for tax purposes.
(If the January lot had a higher price than both the April lot and the current price, you would recognize a loss. The actual tax impact will depend on the prices paid for each lot and the respective selling price. What you will lose under the provision is the option to choose which lot you sell.)
The provision applies to individual securities, but not mutual funds. Rather, average cost basis could continue to be used for mutual funds. As the name implies, the average purchase price for your shares, regardless of when they are acquired, is used to determine your basis. You will also continue to be able to use FIFO or specific identification instead. The specific-share identification method allows you to choose the specific shares that are sold. This treatment can also result in a larger or a smaller tax bill, depending on how the fund has performed relative to the purchase price of the selected shares. You may be able to use other methods such as highest-in, first-out (HIFO) or last-in, first-out (LIFO).
Most mutual funds are regulated investment companies (RICs). An RIC adheres to the Investment Company Act of 1940 (the ’40 Act in industry lingo). Most exchange-traded funds (ETFs) are also RICS, but "J.K. Lasser’s Your Income Tax 2018" (John Wiley & Sons, 2018) says ETFs “are treated like stock.” The book goes on to state, “You cannot use the averaging method for shares in ETFs.” Given this, ETFs would likely fall under the FIFO provision included the Senate’s version.
More information about the taxing of capital gains is in our tax guide. The 2017 guide will be made available online tomorrow (Friday); the same link will take you to the new guide once it’s online. The updated guide contains useful information about 2017 and 2018 tax rates, deductions, exemptions and thresholds. The 2018 numbers are based on existing law; we’ll update the guide should the Tax Cuts and Jobs Act or other significant tax legislation get passed and signed into law.
Regarding advocacy—a question raised by everyone who has called or written me about the bill—AAII is a nonprofit organization. As such, we cannot lobby Congress about this or any other legislation. You, as voters, however, can call your representatives and senators to express your personal opinions.
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My colleague Wayne Thorp will participate in the Alliance for Investor Education’s Funding Your Future investor boot camp. The free event will be held on Tuesday in Washington, D.C. More information and registration is available on this website. AAII is a member of the Alliance for Investor Education.
The earnings calendar only lists six S&P 500 companies: AutoZone Inc. (AZO) on Tuesday; Brown-Forman Corp. (BF.B), Broadcom Ltd. (AVGO) and H&R Block Inc. (HRB) on Wednesday; and Dollar General Corp. (DG) and Cooper Companies Inc. (COO) on Thursday.
The week’s first economic report will be October factory orders, released on Monday. Tuesday will feature October international trade and the Institute for Supply Management’s (ISM) November non-manufacturing index. The November ADP Employment Report and revised third-quarter productivity will be released on Wednesday. On Friday, November jobs data—including the change in nonfarm payrolls and the unemployment rate—as well as the University of Michigan’s preliminary December consumer sentiment survey will be released.
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The latest AAII Sentiment Survey shows the percentage breakdowns of individual investors’ expectations for the short-term direction of stock prices being close to average. Bullish sentiment, neutral sentiment and bearish sentiment are all within a few percentage points of their historical averages.
Bullish sentiment, expectations that stock prices will rise over the next six months, rose 0.5 percentage points to 35.9%. The historical average is 38.5%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 3.1 percentage points to 32.4%. Neutral sentiment is above its historical average of 31.0% for the fourth consecutive week and the 34th out of the last 37 weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded 2.6 percentage points to 31.6%. The historical average is 30.5%.
Bullish sentiment is below its historical average for three consecutive weeks for the first time since early September. Year to date, optimism has been below average on 39 out of 48 weeks.
While the continued rise of the major U.S. stock indexes into record territory is encouraging to some individual investors, many others have previously expressed concerns about the possibility of a pullback or a more severe drop occurring. Tax reform could also be playing a role. While some of our members are optimistic about the prospects of tax reform being passed, about 40% of those polled in a different weekly AAII survey said the proposed legislation could hurt them.
Also having an effect on investor sentiment are earnings growth and economic growth. Other individual investors view stocks as being a bit too overpriced or are concerned about the lack of volatility. Washington politics also continues to be at the forefront of many individual investors’ minds.
This week’s special question asked AAII members how they thought the average consumer is fairing relative to a year ago. The majority of respondents (57%) perceive that consumers are faring better. Job and wage growth, continued economic growth, rising stock prices, low inflation and optimism were among the reasons given. About 16% say the average consumer is faring about the same as last year, while 15% believe the average consumer is faring worse. Stagnant or low wage growth along with rising prices (including housing and health care) were commonly listed as reasons why.
Here is a sampling of the responses:
- “People are feeling better. The markets are up, unemployment is down and wages are rising.”
- “About the same because the small increases in wages are offset by the small rise in inflation.”
- “Better. The economy and the stock market are both improving.”
- “Not well. Prices are going up, while incomes are stagnant.”
- “More optimistic. Employment is up and asset prices are up.”
Bullish: 35.9%, up 0.5 points
Neutral: 32.4%, down 3.1 points
Bearish: 31.6%, up 2.6 points
Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Local Chapter Meetings
November 23, 2017 Reasons for Individual Investors to Be Grateful
November 16, 2017 Choosing Between a Traditional and a Roth IRA
November 9, 2017 Tax Planning In an Uncertain World
November 2, 2017 My Decision to Stick With an Intermediate-Term Corporate Bond Fund
