0

Let's say I have $1000 in an index fund, of which $500 is an unrealized gain (which I need to pay taxes on if I liquidate). For simplicity, let's assume that taxes on gains are 20% and will not change in the future. In other words, I have to pay $100 in taxes if I liquidate now. Let's also assume the fund's average returns are 7% a year.

My holdings are worth less than $1000 as I need to pay taxes on the unrealized gains if I liquidate them now. However, my holdings are worth more than $900 as the unrealized gains can be used to generate further gains.

Is there a formula to determine how much my holdings are worth (net of taxes)? The key consideration is "do I have to retire on?" (as mentioned in Grade Eh Bacon's answer)

6
  • Your holdings are worth $1000, and presumably, $1070 next year.
    – Pete B.
    Aug 23 at 15:57
  • 1
    "I need to pay taxes on the unrealized gains". In what jurisdiction?
    – chepner
    Aug 23 at 17:15
  • OP public profile puts them in the US. Aug 23 at 17:26
  • I'm really looking for a citation supporting the claim that any taxes are due on unrealized gains.
    – chepner
    Aug 23 at 17:31
  • 1
    @chepner I edited it to say "which I need to pay taxes on if I liquidate". I had put this in a subsequent sentence "I have to pay $100 in taxes if I liquidate now", but forgot to put this in the earlier sentence. Hope this makes things clear.
    – wwl
    Aug 23 at 18:02
4

If you don't realize the gain (aka "sell the securities"), then your $1000 is worth -- as Pete B commented -- $1000 this year, and hypothetically $1070 at the end of next year.

Every year (more specifically, at each point in time that you're curious), you must calculate the tax impact for that point in time's unrealized gain.

2

"How much are my holdings worth?" In what context?

In the context of - 'do I have enough cash on-hand to buy a boat this year?' Then yes, you can see the tax rate you would pay, and should adjust your budget for taxes anticipated on selling shares.

In the context of - 'do I have enough to retire on?' Then yes, you should consider the tax implications of liquidating assets, but be aware that the tax consequences down the road could be different than today. Primarily, these differences would arise from (1) changes in tax law in the interim; and (2) difference in your current tax bracket compared to the future - if you pay 20% tax today but your income on retirement is cut in half, probably you will pay less than 20% when you withdraw it.

In the context of - 'did I make the Forbes Billionaire list this year?' then no, such considerations don't typically take into account accrued taxes not-yet-payable.

In the context of - 'how much collateral do I have in the eyes of the bank?' Probably your broker considers the gross value of shares, and doesn't net them by anticipated future taxes, when considering something like whether you have hit the margin limit on your trading account.*

*I'm assuming for this that the broker is not required to withhold taxes on your behalf immediately on liquidating shares; if they are required by law to do so, they might factor that into your margin considerations, but I'm not really sure.

1

It depends.

If you are trying to work out how much the investment contributes to your financial net worth, timing is important. If your taxes are due today and your financial statement says the investment was worth $1000 at the end of the last financial year, and your online account says it is worth $1070 today, then you have something that on paper is worth $1070, for which you need to pay $100 in tax, leaving a notional balance of $1070-$100 = $970 to contribute to your financial net worth.

On the other hand, if you are trying to work out how much tax you need to pay, then you normally use the figure supplied in your financial statement.

Alternatively, if you’re trying to work out some kind of discounted cashflow figure that accumulates provision for tax on a periodic basis, you’d need to factor in your (detailed) profit model as well as the deductions based on the increments you’ve accumulated for tax. An “average 7% return” is probably not going to cut it if you’re going to such detail.

At the other end of the spectrum, you’ve put in $500 and it’s in deep the black even after taxes. So you could say your $500 investment is still worth the $500 you put in, with a fat margin of uncertainty that is currently in your favour.

There are many other alternatives.

So the formula you need depends on what you’re trying to do with the number you’re trying to calculate. Have a discussion with an appropriate financial advisor if you need help working that out. (This answer is not financial advice.)

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.