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My SO and I are planning on buy a house for about $900k. We have $200k in cash, and I'm considering selling several of my mutual funds (non-retirement) to finance the difference. These are funds that I have held for more than 10 years, with no recent contributions.

How can I go about estimating what my tax burden will be? My Google searches typically land on long explanations that boil down to "it's complicated". I'd just like a ballpark number.

Is there ever a situation where a mortgage makes more financial sense - where the mortgage deduction could lessen the bite of that capital gains tax?

Marc
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    Regardless of any answer to your question, getting a mortgage with an SO is risky. There are laws for what happens when married couples split; not so much when the non-married split. We've seen the disasters many times on this site, so my recommendation is talk with your SO, and get lawyers, even though you think you'll never break up. – RonJohn Jul 19 '21 at 14:00
  • The tax burden should be fairly simple: determine your federal CG tax rate, and multiply that by the difference in your sale price and your cost basis (which your broker should be able to supply you). Whether the tax hit is worth it depends on your mortgage term and rate (to determine how much interest you'd pay each year) and your tax bracket (to determine how much tax you'd pay on income not offset by the mortgage interest), as well as your income and other deductions to determine to determine if you even need to itemize to realize the largest deduction. – chepner Jul 19 '21 at 14:06
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    The other question you should be asking is whether, at current mortgage rates, it makes sense to make more of a down payment than is needed to avoid PMI? – jamesqf Jul 19 '21 at 15:26
  • "where the mortgage deduction could lessen the bite of that capital gains tax" - it's a mortgage interest deduction, so large up-front payments actually work against you here: the more you liquidate, the higher your capital gains tax burden. AND since you'll owe less on the mortgage, you'll pay less in interest so your deduction will be smaller – thehole Jul 19 '21 at 22:22
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    don't liquidate, go interest rate! – PatrickT Jul 20 '21 at 07:23
  • Just my 2 cents. You are on the cusp of buying a very expensive house at the potential peak of this covid housing boom. I certainly hope this is a "forever home" and not a FOMO-fueled purchase. – MonkeyZeus Jul 20 '21 at 13:57
  • For that amount of money, you should be asking a professional financial advisor in-person, not random internet users. But it sounds like you are trying to live well outside your means. Maybe reconsider whether you really need a million-dollar home, or if merely a $300k-$400k (still quite expensive) home will do. – TylerH Jul 20 '21 at 15:19
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    @TylerH: That depends on where the OP lives. In some places, $900K is a 3 bedroom starter. – jamesqf Jul 20 '21 at 16:05
  • @jamesqf It's the case in exceedingly few places, almost none of which are actually necessary. – TylerH Jul 20 '21 at 16:36
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    @TylerH I don't know why you got the idea that he is living outside his means when he has enough liquid assets to buy the house outright. – Brady Gilg Jul 20 '21 at 16:44
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    @TylerH: But we don't know whether or not the OP lives in such a place. Nor do we know what the OP is paying for rent or mortgage on a current home, or whether s/he's facing a long commute, or any of a number of other things that could affect a purchase decision, but are outside the scope of the question. – jamesqf Jul 20 '21 at 19:46

6 Answers6

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This decision boils down to 3 factors:

  • interest rate of your mortgage
  • expected return of your funds for the next 10, 15, 20 years
  • transaction cost and taxes

If you expect the stock market to perform better (after costs and taxes) than the interest on your mortgage, do not liquidate anything. On the other hand, with current P/E ratios of the stock market historical returns on the stock market have been rather low and it is quite realistic that a 10 year return from now might be only 1% annualized or even negative. In this case liquidation might be a good idea as you lock in your current gains and reduce the debt right now. It then comes down to a calculation how much you will lose by paying taxes earlier. This decision again could be dominated by expectations as Pete B. outlines in his answer. I will leave it as a link as I am not familiar with the details of US taxation and the intricacies of US politics.

So bottom line: The is no perfect solution. It all boils down to your expectations of future returns and taxes

edit:
There seems to be a bit of confusion what I mean with low returns. I am refering to the correlation of high valuations with forward returns. As an example take the following figure which plots the 10 year forward return against historical values for the CAPE. Note that this is from a 2015 article and markets have moved even further into high valuations since. This suggests that returns for the medium future will rather not be 10% annualized just because that was the historical average. Considering that a mortgage in the US is somewhere around 2.5-3% interest and this is both a guaranteed and "tax free" return, realizing gains and reducing debt does not look like such a bad option. enter image description here (source)

Manziel
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    historical returns on the stock market have been low, last year's have been ridiculously high, so now they'll probably be ridiculously high in the other directly. Or will they? Nobody knows. The market will crash right after you go all-in. – user253751 Jul 20 '21 at 08:20
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    @user253751 - "historical returns on the stock market have been low". What? 10.73% CAGR over the last 100 years. 7.45% this century, including the first awful decade. – JTP - Apologise to Monica Jul 20 '21 at 12:19
  • @JTP-ApologisetoMonica well, I assume that counts as "low" or else I can't figure out what Manziel is calling low. Also note that the USA's stock market (which must be the one you're referring to) is an outlier. – user253751 Jul 20 '21 at 12:54
  • I added a paragraph to clarify what I meant. – Manziel Jul 20 '21 at 13:20
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    I think you are missing an important factor here: inflation. You can lock-in a 30-year mortgage at an extremely low rate. If inflation rates rise (which a lot of people think is inevitable), your mortgage becomes less expensive over time and your home will tend to be worth more. Likewise, stocks also tend to rise with inflation. 100K today is worth more than it will be in 10 years. I say let the bank/government eat inflation. – JimmyJames Jul 20 '21 at 15:08
  • Expected inflation is already contained in the interest rate. If you are considering inflation as an important factor you are betting that the inflation will be higher than the bank estimates. And high inflation does not guarantee good stock returns. Just consider the 70s, where high inflation met high valuations for stocks. The real returns on the stock market were pretty bad. – Manziel Jul 20 '21 at 15:36
  • "If you expect the stock market to perform better (after costs and taxes) than the interest on your mortgage, do not liquidate anything." So you're saying if I expect the stock market to go up I should take a huge mortgage on my house and buy stocks on credit? Because that would lead to the exact same situation, but funnily, if you ask that way, the advice often differs ... – DonQuiKong Jul 20 '21 at 20:39
  • Yes, the question is basically the same just framed in a different way and people will answer the framing, not the real risk. (For example see the terrorism vs any death question in https://www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/1137/Copy_of_Framing_Probability_Distortions.pdf) – Manziel Jul 21 '21 at 06:58
  • I'm not talking about the effect of inflation on stock returns. You really think anyone knows what inflation will be in 10 or 20 years? I know exactly what my interest rate on my mortgage will be in 20 years. – JimmyJames Jul 21 '21 at 13:05
  • @DonQuiKong How is that the same situation? A 30-year mortgage that has a fixed rate is nothing like buying stocks on margin. There are no margin calls on mortgages. If you can show me where I can get a 30-year loan at less than 3% in order to buy stocks, yeah, I might consider it. – JimmyJames Jul 21 '21 at 13:07
  • This isn't really logically coherent: "markets have moved even further into high valuations since. ... realizing gains and reducing debt does not look like such a bad option." We are talking about existing investments here. What you are suggesting is that because valuations are going to go up, sell those investments now. – JimmyJames Jul 21 '21 at 13:33
  • The basic principle of investing is buying low and selling high. We are definitely at high valuations right now. Valuations cannot decouple from fundamentals for more than a certain time, which is reflected by low returns if one starts at high valuations. Valuations are either corrected by falling stock prices or improving fundamentals without major changes in stock prices (or a combination of both). Anyways, high returns are unlikely. This is not selling because valuations rise but because they have risen. – Manziel Jul 21 '21 at 13:45
  • The data you are sighting and the logic around returns and valuations is about expected return on new investments into the market. When valuations rise, it doesn't reduce returns on investments bought at lower prices. If the OP sells all his investments, they will have no mortgage, but also no investments. What's the next step? – JimmyJames Jul 21 '21 at 14:27
  • My mistake, the OP implies other investments. The question then becomes what to do with the 'tax free return' of maybe 2.5%. If we assume that returns are going to be lessened for new stock purchases, selling, paying capital gains taxes, losing out of gains (because of higher valuations) to buy back in over time is a questionable strategy. – JimmyJames Jul 21 '21 at 15:28
  • @JimmyJames I said: take out a loan with your house as collateral. That should give you 30 years fixed interest. – DonQuiKong Jul 21 '21 at 17:07
  • @DonQuiKong Ah, I misinterpreted what you wrote. So you are saying that, if you own your home outright, take a mortgage against it to invest in stocks? It's not totally crazy, I've heard of such recommendations in the past and people do back business loans with their homes quite often. The question is how you plan to pay it off and what your goals are. It might actually be a better alternative to a reverse mortgage, if you can find very low-risk investments that return enough to cover the interest. – JimmyJames Jul 21 '21 at 17:57
  • @Manziel - I retired in 2012. And a fellow PF blogger was promoting the concept your graphic showed. His strongly advised I be 100% in bonds/cash. Instead, I was 80/20 or so, stocks/cash. Nearly 9 years later, my net worth has more than doubled along with these years of living off savings. There is no 15 period that had a negative return. 10? I haven't spreadsheeted yet. Been studying 15. – JTP - Apologise to Monica Jul 21 '21 at 22:30
  • The linked source also has a graphics for 20 year returns. The message is the same, higher valuations mean lower expected returns for the future. And it is not enough to have a non-negative return over a period of x years if you are in debt at the same time. Return minus taxes minus costs needs to be greater than your interest payment. So again, this all boils down to expectations. And please note, this does in no way call for 100% bonds/cash because bonds also have a low expected return if interest rates are low. – Manziel Jul 22 '21 at 06:51
  • Also for the actual question, we are lacking a lot of information. How old is the OP? How is his income situation? Given the net worth we probably do not have a 25 year old, but rather someone older. Taking a mortgage into retirement can be problematic – Manziel Jul 22 '21 at 06:55
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It really is not that complicated to figure the tax on capital gains. For assets that you have held longer than a year, you pay taxes at the long term capital gains tax. Now, despite having held the funds for longer than 10 years, not all gains could be considered long term. Recent dividends and capital gains; and contributions, that occurred less than a year ago may be subject to short term capital gains.

You pay taxes on the gains. If you paid 100K for funds that are now worth 500K, you would owe taxes on the difference, or 400K.

Currently the short term capital gains tax is 0, 15%, or 20% which will depend upon your income. However, the Biden administration has promised to shake up how this is done and all capital gains may be taxed as ordinary income.

So there are a lot of variables in place, here are some to consider:

  1. How much of that 700k is actually gain?
  2. What is your current income?
  3. What is the cost to originate a mortgage?
  4. What will the future income tax climate be like?

A person may be better off cashing out all mutual funds now, paying cash for the house, then getting a mortgage and rebuying the same mutual funds. This would give a person a stepped up basis for capital gains and avoid higher capital gains taxes if they come to fruition. Keep in mind, that even if they do come to fruition, they could be changed back by future administrations.

The complication is making the optimal decision. Given the amount of variables and needing to predict the future, it is pretty much impossible to make the perfect decision.

In these kinds of cases you might be better off with a partial decision. Sell some assets to reduce the amount of the mortgage but still get a mortgage. Then reevaluate next year. Do you take out 50K and use those assets to pay down the mortgage? Maybe/maybe not.

Factoring in the mortgage interest deduction also adds a layer of complications to this calculation. In the past, just about everyone qualified for the mortgage interest deduction. However, now a lot less people do because the standard deduction is so high, there are limits to the amount of interest one can claim, and the rates are so low.

Here I would not suspect this will change with future administrations. Both parties have shown a keen interest in simplifying income tax returns. The large standard deduction does exactly that.

I am not sure of your google search, but this page was pretty comprehensive.

Pete B.
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    I don't know about the US, but in the UK you are unlikely to get an immediate remortgage on a property you bought for cash, because doing that is an obvious illegal-money-laundering strategy. More likely, you would be out of the equity markets for 6 or 12 months before you could remortgage the property. – alephzero Jul 20 '21 at 02:44
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    @alephzero Actually it should be OK. When you buy the house, your conveyancing solicitor (the lawyer handling your side of the deal, for non-Brits) has to trace where that cash came from, with evidence. They sign off on you not being money-laundering, and the other side also need to see that evidence before the sale can go through. Not to say that money laundering can't happen, but it needs the active involvement of two sets of lawyers. – Graham Jul 20 '21 at 07:31
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One aspect to keep in mind might be the leverage resp. the opportunity cost of selling your funds now.

If you think that you can make a higher profit (percentwise) than the interest rate of your mortgage would be, and you can afford the monthly mortgage payments even if your investments take a dip, it may be more adviseable to take the mortage.

This gives you two advantages:

  • no capital gains tax right now
  • keep your investments rising, making you money
glglgl
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  • Leverage is a very important part. Simplified example: if your downpayment is 10% and your initial house costs $500k, then after 1 year you owe ~$440k to the bank. But, if your house appreciates to $600k (not uncommon in the last year), the entire $100k in extra profits is all yours - you could liquidate your house on the spot for a crazy 420% in profits ($50k invested, $160k extracted). You won't get returns anywhere as crazy if you keep your house longer than that, but the general principal stands. – JonathanReez Jul 20 '21 at 02:45
  • @JonathanReez and if the housing bubble crashes ($900k house?!) you owe more money than the house is worth, and your stock investments probably crashed too. – user253751 Jul 20 '21 at 12:16
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    @user253751 yes which is why it’s important to be ready to actually live in the house for a long time in case the market crashes. People who bought in early 2007 were only be able to sell for a profit recently. – JonathanReez Jul 20 '21 at 13:52
  • @JonathanReez and important to not over-leverage yourself. Your stock market holdings are now worth $3.50, your house is $3.50, you lost your job and you owe the bank $800000. Congratulations, you and all your descendants are now slaves for life to repay that. Of course I'm exaggerating a bit. – user253751 Jul 20 '21 at 14:15
  • @user253751 in many US states you can just walk away from your mortgage if it was for a primary residence. You lose your down payment and any principal payments you’ve made so far, plus tank your credit rating, but you’ll still have your other savings intact. Shitty scenario to be sure but the beauty of it is that the leverage is effectively one way, the bank carries most of the risk. – JonathanReez Jul 20 '21 at 14:21
  • @JonathanReez in these places are you required to have a credit history to rent a home? – user253751 Jul 20 '21 at 14:27
  • @user253751 yes you’ll indeed have trouble renting, but you could get away with it by renting from small landlords generally. – JonathanReez Jul 20 '21 at 14:37
  • @user253751 There is no transfer of debt to descendants in the US. – JimmyJames Jul 21 '21 at 14:39
  • @JimmyJames there is if they co-sign it! – user253751 Jul 21 '21 at 15:18
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    @user253751 It's usually it's the parents cosigning the children's loan, not the other way around. Regardless, that's not inheriting debt, it's a loan that you personally took on. – JimmyJames Jul 21 '21 at 15:21
  • @JimmyJames correct, and when you don't pay it yourself, it's a debt which you have transferred to your descendant. Oh, you were talking about "your descendants are now slaves for life". Sure, the debt isn't theirs... but the consequences are! Imagine being raised homeless. – user253751 Jul 21 '21 at 15:44
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    @user253751 The goal posts moved to an entirely different field on a different continent for a different game. – JimmyJames Jul 21 '21 at 15:52
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How can I go about estimating what my tax burden will be?

  1. Figure out your cost basis. That's basically how much you paid for your shares including re-investment. Your brokerage should give you the cost basis for each of your funds. With a good broker, you can access this online.
  2. The difference between the current price and the cost basis is your capital gain. If you hold it for more than a year it's "long term". Otherwise it's "short term".
  3. The federal tax calculation is indeed insanely complicated since the US tax code is really effed up. In "many" cases the long term gain will be taxed at 15% but it can vary anywhere between 0% and north of 30%. Hence "it's complicated"
  4. There is also state tax to consider. E.g. short term capital gains in Massachusetts are taxed at a whopping 12% on top of whatever the feds want.

Is there ever a situation where a mortgage makes more financial sense - where the mortgage deduction could lessen the bite of that capital gains tax?

Sure. If you think that your funds will provide a higher rate of return than the interest of your mortgage, you should go with the mortgage. Taxes makes this again insanely complicated but for "normal" cases this often comes out to be a wash.

Hilmar
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Other answers focus on optimizing the total profit of the investments against the cost of the mortgage. There is another aspect to consider: cash flow security.

What happens if your income drops for a while?

If you have a mortgage and some mutual funds, you can just keep paying your expenses from the funds.

If you have neither of these, you'll need to find a new source of income before your emergency savings run out. Typically it is difficult to get a new loan with good interest rate if you already have insufficient income.

jpa
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Is there ever a situation where a mortgage makes more financial sense

  • where the mortgage deduction could lessen the bite of that capital gains tax?

The mortgage deduction is a case of the tax tail wagging the investing dog. My 3.5% mortgage nets at 2.73% after federal tax deduction. In effect, this is a 'discount' of .77% on the cost of my mortgage. Tiny in comparison to the 10.73% (CAGR) return of the S&P over the last 100 years, or the 11.64% return over my own investing lifetime, i.e. since 1985.

We have a great Q&A, Oversimplify it for me: the correct order of investing in which my own answer suggests that paying off a mortgage sooner should come 6th, after a list of other debt/investments. On reflection, I'd say that letting a mortgage run its course, and in some cases, stretching it out longer than the traditional 30 years, makes more sense.

Good question, but we don't know the 'rest of the story'. Are you depositing to 401(k) or other retirement accounts? Do you have any other debt? It's far easier to put 20% down, and realize that you are still sitting on cash you'd prefer to not invest and pay down the loan a bit, than the opposite. Send all of your liquidity to the deposit, and then have all of the expenses of a new home, and find you are cash-poor. As others noted, liquidity is pretty valuable.

JTP - Apologise to Monica
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  • A sensible answer. In addition to expenses that come with a new home, there are maintenance costs (expected and unexpected) that you might not understand if you've never owned a home before. – JimmyJames Jul 21 '21 at 14:31
  • Thank you. I resisted the urge to start listing all the expenses of items that aren't / can't be noted during an inspection, but due to age, fail early on. The 'redecorating' could have been another super long list. – JTP - Apologise to Monica Jul 21 '21 at 14:48
  • I think 'really long list' sums it up pretty well. The things that really get people, in my experience are things like fixing a foundation, putting on a new roof, fixing sewer lines, etc. They aren't fun or exciting but they will cost you plenty and if you don't do it, it can destroy the value of your home which, if you've liquidated all your assets, is now the basket where you've put all your eggs. – JimmyJames Jul 21 '21 at 15:04
  • I see now that the OP implies not only that they have more retirement investments as well as other investments beyond the 700K. The decision of whether to buy outright is a little more nuanced in that situation. – JimmyJames Jul 21 '21 at 15:13