Short term treasuries and high state/local income tax

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Short term treasuries and high state/local income tax

Postby sophie » Tue Dec 12, 2017 8:45 am

I just moved some cash into high-coupon short term treasuries and just for fun, calculated my tax equivalent yield for the maneuver. Just thought it would be worth sharing, because depending on your tax situation, the strategy handily beats CDs. However, you need to be careful about this if you have long term capital gains (see below).

The strategy is to buy a treasury bond close to maturity with the highest coupon rate you can find. Here's how it works for a $15,000 investment and my specific tax brackets (28% federal, 11% state/local):

Purchase price: $15,606 (of which $125 is interest) for bonds with face value of $15,000 at 9.125% coupon. Last payment is in May 2018 of $684. There will be a built-in loss of $481 when the bond matures.
Federal taxes on the interest: $156
The bond will generate a short term capital loss, to be applied against short term cap gains or ordinary income. NOTE: you don't want this to be applied to long term capital gains, as instead of getting 28% on the loss, I'd effectively only get 15%.
Tax savings from short term capital loss: $135
State/local tax on interest is zero
State/local tax savings from the capital loss: $53 (same warning about long term capital gains).

Totaling up these numbers, you end up earning $110 after taxes. This is an 0.7% effective interest rate at 5 months, or 1.7% on an annual basis. To earn this from a CD, you'd need one paying 1.15% for the 5 months, or 2.8% annually. Right now, I couldn't get that even for a 5 year CD. The long term capital gains might become an issue for me though...I've got a stock index fund in taxable that generate a small amount of long term capital gains when the yearly dividend comes around.
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Re: Short term treasuries and high state/local income tax

Postby whatchamacallit » Tue Dec 12, 2017 10:08 am

Very nice benefit considering treasuries are the preferred instrument anyway.

Thanks for sharing.
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Re: Short term treasuries and high state/local income tax

Postby pugchief » Tue Dec 12, 2017 1:36 pm

If you have $25,000+ to invest, Ally has an 11 month no-penalty CD paying 1.6%, FDIC insured. If rates rise, you call in the CD with no penalty and reinvest at a higher rate. If rates stay the same or go down, you hold until maturity. No need to worry about capital gains/losses, and a lot less line items on your 1040.
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Re: Short term treasuries and high state/local income tax

Postby jhogue » Sun Dec 17, 2017 9:41 pm

I used Sophie’s “tax trickery” with high coupon short term Treasurys a couple of years ago. We sold our old house and had to park the proceeds in something cash-like for a short time while we finished building a new house.

An additional consideration was that the amount of cash we parked exceeded the FDIC covered account limit of $250,000. I did not want the hassle of opening another account with another FDIC-insured bank or brokerage just to be sure we were covered.
“Groucho Marx wrote:
A stock trader asked him, "Groucho, where do you put all your money?" Groucho was said to have replied, "In Treasury bonds", and the trader said, "You can't make much money on those." Groucho said, "You can if you have enough of them!"

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