Jose DiCenzo has some securities worth €50,000 that have a cost basis of €75,000. If he sells those securities and can use the realized losses to offset other realized gains, how much can DiCenzo reduce his taxes in the current tax year assuming capital gains are taxed at 30 percent?
-> 0,3 x the loss (25k) = 7,5k - amount of taxes reduced
Suppose DiCenzo sells the securities in the current tax year and replaces them with securities having the same returns. He will then sell the new securities in the next tax year. What is the total tax savings assuming DiCenzo does not reinvest the tax savings?
Why is it zero, in this case?
Could someone pls tell?
Thanks!
Suppose you reinvest back just the EUR50,000 this tax year and the return is 20% p.a., then next year the security value is EUR60,000 => gain = EUR10k => tax payable on gains = 30% × EUR10k = EUR3k.
Since you are paying taxes, definitely there is no tax savings.
So, the question refers to “if he does not reinvest the tax savings NEXT YEAR”? Btw isn’t it a bit early in the U.S. as we speak? 
cool that I got you online
*my bad. Now saw you’re in Malaysia!
Yes, so it is like 7.38 pm here in Malaysia
Whether he reinvests the tax savings in the current year or not (with the sales proceeds), there will be no tax savings in the next year when he sells as there is a gain.
At least thats how the question sounds like. This is from CFAI online?
No, EOC question.
Ok I saw the question.
Let’s assume that:
- Jose has realized capital gains in the current year amounting to EUR 155,000.
- If Jose does not sell the securities, the value would have went up by 80% in the following year (EUR 50,000 x 1.80 = EUR 90,000).
Scenario 1: Do not use loss-harvesting strategy; sell securities NEXT YEAR.
Year 1 capital gains tax = 30% x EUR 155,000 = EUR 46,500
Year 2 capital gains tax = 30% x (EUR 90,000 - EUR 75,000) = EUR4,500
Total tax paid for Year 1 and 2 = EUR 46,500 + EUR 4,500 = EUR 51,000
Scenario 2: Use tax-loss harvesting strategy, sell securities NOW and REINVEST sales proceeds into similar securities.
Capital loss on selling = EUR 75,000 - EUR 50,000 = EUR 25,000
Year 1 capital gains tax = 30% x (EUR 155,000 - EUR 25,000) = EUR 39,000
Compared to Scenario 1, there is tax savings of EUR 46,500 - EUR 39,000 = EUR 7,500.
The EUR 50,000 sales proceeds is reinvested into similar securities (cost basis = EUR 50,000) and by next year, the value will be EUR 50,000 x 1.80 = EUR 90,000.
Year 2 capital gains tax = 30% x (EUR 90,000 - EUR 50,000) = EUR 12,000
Total tax on capital gains for Year 1 and 2 = EUR 39,000 + EUR 12,000 = EUR 51,000
So, in conclusion, if the tax savings in the first year (EUR 7,500) was not reinvested, then there would be no difference in the total tax paid in Year 1 + Year 2 (i.e. Total Tax Savings = 0).
Ah, that is why it is zero, because there is no difference between the years. Got it, thanks for the comprehensive example!
I’d have one more question, though… when Jose is selling the new securities in the next tax year (I am herewith referring to the original EOC question text), because those securities have the same return as the ones replaced, does this automatically mean they will “climb back” to 75k?
Year 1: had a security worth 75k, dropped to 50k, loss of 25k, tax savings = 7,5k
With the 50k earned on selling those securities, you buy identical ones, worth again 50k. They climb to 75k. So, you have a gain. You owe tax of 7,5k.
Year1 plus Year 2 = 0 (what you manage to save in year 1 in taxes, you owe in year 2 on the gain).
Am I correct in this explanation?
Muchas gracias
Comments above
Blockquote
It will “climb back” to 75k if you assume the returns on the similar securities is 50% (EUR 50k x 1.5 = EUR 75k).
Blockquote
Well, the way I read the question, replacing the securities with other ones, having the same return, means that yes, they’ll increase back to 75k. Otherwise, if the securities increase over 75k, or under 75k, than the amount owed in taxes is not getting offset by the tax savings from Year 1 anymore, so the answer cannot be 0.
Sorry for this, I am sometimes having troubles understanding the wording on some questions…
Oh no no.
Let me use numbers to illustrate.
Jose DiCenzo has some securities worth €50,000 that have a cost basis of €75,000. These securities are expected to have a return of 80%.
Suppose DiCenzo sells the securities in the current tax year and replaces them with securities having the same returns.
Which means the similar securities you replace it with will also have a return of 80%.
Oh, alright. So the idea is, no matter what the return is, be it 50%, 90% etc, in the end, the combined effect is 0… thanks again!
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