Tax on a Liquidated Mutual Fund
Q: Years ago I invested $5,000 in a mutual fund. My investment is now worth about $80,000 and I plan to liquidate it at the rate of about $1,000 per month. How would I compute my tax liability? --R.W.W.
A: Your first step should be to verify with the fund administrator the exact amount of your reinvested dividends, on which we will assume, for the purposes of this discussion, that you have already paid taxes. Next, compute your tax basis by adding together your initial investment and any dividends on which you have already paid taxes. To figure your taxable gain, simply deduct your basis from your proceeds.
Obviously, this works best when you liquidate the entire fund at once. However, the formula can work as well when you take a partial distribution. All you do is compute your overall percentage gain and apply that ratio to the amount you withdraw each month. For example, if your basis is $40,000 and your entire investment is worth $80,000, then half of whatever withdrawal you make is taxable income. If you elect to withdraw $1,000 per month, $500 of that will be subject to your ordinary income tax rate.
While tax experts consider the above method to be preferable for regular periodic withdrawals, there are other formulas available to taxpayers liquidating only a portion of their mutual fund holdings.
One is to specifically identify the shares you are selling before completing the transaction. This allows you to select those shares whose tax basis fits the amount of taxable proceeds you want to generate. The other method, popular for its simplicity, is to elect the “first in, first out” system, under which the first shares you purchased are the first to be sold.
Estates Cover Tax on Certificates of Deposit
Q: A close family friend made me a beneficiary of one of her certificates of deposit before dying recently. I have taken the money from the account. What are my tax consequences? --L.M.C.
A: The certificate should have been included in the estate of your deceased friend. If there were any estate taxes due the government, the estate should have taken care of it. Assuming this took place, you should not have a tax obligation.
Figuring Tax on a Mortgage Taken Back
Q: I bought my house years ago for $37,000 and will be selling it soon for $300,000. I plan to carry the mortgage back after taking a down payment of $60,000. How do I figure the taxable portion of the monthly payments that I will be receiving? --R.A.
A: For the purposes of the example, we’ll assume that $37,000 is your tax basis in the home and that your net proceeds from the sale are $300,000, giving you a gross taxable gain of $263,000, or 87.6% of your proceeds. You would use that ratio to determine the taxable portion of the down payment you collect: 87.6% of $60,000 is about $52,560. You should also apply that ratio to every dollar of principal that is paid by the buyer. However, the entire interest portion of the monthly payment would be taxable.
Although you didn’t ask, our advisers recommend that sellers taking back a fixed-rate mortgage limit its length to a maximum of 10 years to protect themselves against fluctuating interest rates. You can still offer a mortgage whose payment amounts reflect a 30-year amortization, a feature most home buyers want and need. However, you would stipulate in the agreement that the full mortgage balance is due and payable in five, seven or even 10 years. Since the average length of home ownership is less than 10 years, most home buyers should find those terms acceptable. If at the end of the loan the buyer wants to extend it, you can renegotiate the terms.
Managing Your Money in Illness or Death
Q: My mother wants to put my name on her savings and checking accounts in case she falls ill and is unable to take care of her affairs. If she does this, will the IRS consider the money in the account to be a gift to me from her? She wants everything she leaves behind to be split equally between my brother and me. --C.W.
A: Simply adding your name to a checking or savings account does not constitute a gift of any funds in those accounts. Your name can be added to the accounts and any proceeds in those accounts can be split with your brother upon your mother’s death without additional complication. Any funds in those accounts would be considered a part of your mother’s estate and would be subject to whatever taxes her entire estate warranted.
However, your mother may want to consider an alternative method of protecting herself in the event of severe illness or incapacitation. Our advisers recommend that your mother execute a “durable power of attorney” naming you as her stand-in should she become incapable of handling her own affairs. This process is simple and offers your mother far more protection.
As long as we are on the subject, your mother also might want to consider executing a “durable power of attorney for health-care decisions.” This document allows anyone--in this case your mother--to give another person the right to make health-care decisions for her in the event she is unable to give “informed consent” about her care. If she does become incapacitated, you--as her stand-in--would have the authority to consent to her doctor withholding treatment to keep her alive. You also could consent to the donation of her organs upon death. Many people execute these documents, which are good for up to seven years at a time, to insure that their health-care wishes are adhered to when they are unable to speak for themselves.
These documents should be available from your attorney or from the California Medical Assn. To obtain the documents from the CMA, send a $2.15 check to Sutter Publications, P.O. Box 7690, San Francisco, Calif. 94120-7690.
