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I am facing a tax issue, but let me preface it by saying this is a good problem to have. I have been blessed to see some massive gains in one particular stock I hold in my portfolio. My plan is to use these gains to completely pay off my mortgage (I told you they were massive) which will be liberating on a level that I cannot explain. The small issue (good problem) is that this will lead to a huge tax liability and possibly push me into another tax bracket. I have held the positions longer than a year, so the gains do qualify for long-term capital gains tax. I am open to all ideas offered. Thanks in advance for any suggestions.  

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I wouldn't let the chance of temporarily moving into a higher tax bracket dissuade you from your goal of paying off your mortgage.    As time goes by your high performing stock could fall back down in value and spoil your plans.    However,  if you are really keen on not being bumped into a higher tax bracket and you feel pretty sure the stock will maintain its value, you could always sell a certain percentage of the stock this year that still keeps you in your current tax bracket.  You could then sell the remainder of the stock next year (or years).

You may also want to check with your bank about any penalties on paying the mortgage off early.

K

I'm going to assume there is no penalty for early prepayment because that's a bit unusual. If it is, it would completely change the calculation.


For longterm capital gains, you get the first $10,000 for free, then it's 15% up to $500k, then it's 20%. Your mortgage probably is lower than 5% interest, so it doesn't seem worth it to pay more than 15%.

The numbers completely define the answer. Here is an example
If you owe $200k on a mortgage, then you can just pay the 15% on $190k which is $28.5k
Consider what happens if you pay slower.
For a mortgage of $200k @3.5% for 30 years, you are paying $123k in interest so it may be better to prepay if you don't consider your other investment growing.

If you instead paid $100k each year, you get $10k for free, pay 15% on $90k. You pay off $100k of your mortgage. You pay approximately 3.5% on the remainder, which is $3500, then you pay off the remainder the next year which is a bit less than $100k. Let's call it $97k, because your payments paid off $3k of the loan since you had prepaid so much. It might be a bit less, I'm too lazy to calculate that. Your second year payment then is $97k. You take your first $10k profit, leaving $87k on which you have to pay 15% tax which is $13050.

So the total you paid by breaking it into two years is $26550 + interest of $3500, total = $29550. Since this is more than  the tax for paying up front you might as well just pay it off. But this assumes your invesment won't be growing faster than the rate of interest.

Let's say your investment will continue to grow at 5%, but there is a risk it won't grow one year (but will not lose money). In such a case, your logical course of action is to pay off the loan at the original rate, since your investment will grow faster than the interest. You will eventually have to pull it out and pay taxes, so you could pull out $10k a year tax free and use that to pay the mortgage.


However if you more than $500k on your mortgage, then every dollar above $500k is taxed at 20%. It is worth waiting one year as long as the interest is less than the 5% increase in the tax rate.

In reality of course, your mortgage is definitely there, and you can never tell when your investment will crash. So you have to decide how safe you want to play it.

V
@Knightlight posted:

I wouldn't let the chance of temporarily moving into a higher tax bracket dissuade you from your goal of paying off your mortgage.    As time goes by your high performing stock could fall back down in value and spoil your plans.    However,  if you are really keen on not being bumped into a higher tax bracket and you feel pretty sure the stock will maintain its value, you could always sell a certain percentage of the stock this year that still keeps you in your current tax bracket.  You could then sell the remainder of the stock next year (or years).

You may also want to check with your bank about any penalties on paying the mortgage off early.

Thanks for the reply.  You make several great points. I definitely don't want a fall in the stock price to spoil my plans. I have already seen some correction. I have decided to sell off shares each month for the next several months and retire the mortgage by year's end. I am offsetting my tax liability by increasing contributions to my traditional 401k and 457b plans. I really appreciate the sound advice. I will post back here to let you know how it turns out.

AM
@vodster posted:

...
For longterm capital gains, you get the first $10,000 for free, then it's 15% up to $500k, then it's 20%. Your mortgage probably is lower than 5% interest, so it doesn't seem worth it to pay more than 15%.

The numbers completely define the answer. Here is an example
If you owe $200k on a mortgage, then you can just pay the 15% on $190k which is $28.5k
Consider what happens if you pay slower.
For a mortgage of $200k @3.5% for 30 years, you are paying $123k in interest so it may be better to prepay if you don't consider your other investment growing.



In reality of course, your mortgage is definitely there, and you can never tell when your investment will crash. So you have to decide how safe you want to play it.

Thanks for the thorough evaluation with some numbers to support it. You offered a lot of info which I appreciate. I think the interest over the next 30 years compared to the tax liability for this one year makes it clear. I have decided to sell off shares each month to pay off the mortgage by year's end. I am also setting aside a portion of the proceeds for taxes due next year. This will be a huge milestone for me and increase my monthly cash flow in order to start new investments. Thanks for the advice.

AM

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