Roth Conversions and unrealized capital gains tax implications

[babytomato]

(NB: I've already reached out to tax professionals, just curious what knowledgeable folks here think in the meantime.)

My partner and I are studying on a student visa for 2 years in Tokyo. Our budget is $40,000 the first year, and $40,000 * 1.03 (3% inflation factor) the second year. We have enough cash set aside for both years, but wanted to invest all of the cash for the second year in a U.S. brokerage to let it grow. In the second year, we'd sell stocks that we've held long-term to fund our life, quarterly. We live pretty simply and are used to budgeting and tracking expenses, so I suspect that we won't have problems keeping our annual expenses below $40,000.

My long-term U.S. tax strategy has been to pay zero federal taxes due to the high LTCG 0% bucket - about $94,000 in 2024 when Married Filing Jointly - and living off of stock sale proceeds (we need substantially less than $94,000 in non-capital gains dollars to live annually). After selling off stock to fund our life, I'd then fill up the rest of the LTCG allowance in the 0% tax bracket with capital gains harvesting: selling and rebuying stock to bump up our cost basis, thereby reducing our capital gains tax liability for future years. Then since I wouldn't be working (I've entered FIRE), I'd fill up the U.S. Standard Deduction ($29,200 for 2024) with a Roth Conversion, pay zero taxes on the conversion.

Some questions to check my understanding of how this maps to the two years we'll spend in Japan:

1. Is it true that when doing capital gains harvesting (selling then buying back immediately to bump the cost basis), as long as the proceeds are not remitted to Japan, and the stock was originally purchased when not an non-permanent resident (NPR) of Japan, I won't be taxed on the LTCG?[sup]1[/sup]
2. If 1) is true, and I do capital gains harvesting which includes re-buying U.S. stocks at the end of my first year here, do I then have to pay unrealized capital gains tax on that bought stock for that tax year even if I don't sell while I'm in Japan? If I leave before the end of the tax year without selling, would it be included as part of some exit tax?
3. What portion of the remitted proceeds from a stock sale is taxed in Japan - the capital gains, or the total remitted amount?
   • For a specific example, if we're planning to fund the 2nd year in Japan with proceeds from a $40,000 gross sale amount with 10% capital gains profit, is our tax obligation then 20% * 10% * $40,000 = $800, or 20% * $40,000 = $8,000?
4. If I do a Roth Conversion of up to the U.S. Standard Deduction amount in a tax year, while an NPR in Japan, I'll be able avoid paying U.S. taxes, but will I be taxed in Japan?

I'm also curious to hear from any Americans that have achieved FIRE in Japan. 20% of capital gains proceeds can be pretty big, so I'm wondering how folks make this work in the long-term. Maybe it's worth it when comparing Japan's quality of life to the U.S., even if one can pay zero taxes the U.S. (both capital gains and income tax) when FIRE.

Thanks!

[sup]1[/sup]The guide in this thread from @tricky says that I'll be taxed as long as the stock sale happens when I'm a tax resident, but I don't think that's true, given this PwC document, specifically the part regarding exemption (see screenshot).

https://preview.redd.it/wt5wchayr3p...bp&s=aa793fe3cbe73c4113d71278152b8afada27f8cb

 

[twhi]

@babytomato I'm not an expert, but here is my understanding.

1. Your statement implies that you would send money other than the proceeds from your capital gains. This would be considered remitted income, as described in Article 17 of the Order for Enforcement of the Income Tax Act. So for your particular situation (i.e., no Japan source income paid abroad), any funds sent to Japan will be considered to be remitted income up to the amount of capital gains (edit: and any other foreign income). Also, note that use of foreign credit cards in Japan is considered as remitted income.
2. If you are here on a two year student visa I don't believe you would be subject to Exit Tax. According to this PWC document, it doesn't apply if you are on a Table 1 visa. (But note that if you purchase stocks while NPR and sell them while NPR, they are considered taxable income. See this PWC document for details. Also keep in mind that Japan tax law specifies FIFO as the basis for capital gains tax acquisition date, as explained in this Deloitte document.)
3. Remitted income is what is taxed (see item 1 above). Practically speaking, the amount of remitted income for your scenario will be the amount of funds remitted to Japan up to the amount of capital gains income and any other foreign source income. (Also, keep in mind that capital gains are calculated as the sale price in yen minus the purchase price in yen, using the exchange rate on date of sale and the exchange rate on date of purchase. So changes in exchange rate may result in a so-called phantom gain or loss.)
4. As you mentioned in your reply, this might be considered as income and the amount remitted to japan would be taxable. See #1 above regarding what is considered remitted income.

 

[kristhuy]

@twhi

Japan tax law specifies the FIFO as the basis for capital gains tax

Just to clarify, FIFO only applies to the determination of the acquisition date of shares sold by a non-permanent tax resident. The taxpayer's cost basis in the relevant shares is always determined via the moving average method. Japan does not allow taxpayers to use FIFO to calculate their cost basis.

 

[twhi]

@kristhuy Thanks, I fixed my reply.

 

[babytomato]

@twhi Thanks for your point-by-point answers. Some follow-ups:

1. I was talking strictly about capital gains harvesting. In this scenario, you don't remit any money to Japan, you simply sell stock and buy again to increase your cost basis. Crucially, in this case, none of the stock that I'm selling was bought while I was NPR in Japan. So I wanted to confirm (based on my screenshot in the OP) that there's no tax on capital gains in this scenario. Point 2 is an extension of this scenario. This thread seems to already confirm that; it's also spelled out here in the wiki.
2. What if I purchase stocks while NPR (from 1), and sell them while not NPR (say when I move back the the U.S.)? Would I owe Japan any taxes on the capital gains, since I'm selling stocks that was bought while NPR? Capital gains harvesting is something that can be done every year, so it's conceivable that after year 2, I repeat the process with stocks bought in 1 while I was NPR.
3. Acknowledged, thanks for the clarification and the reminder about phantom deltas. Regarding the specific scenario of a stock sale with $40,000 gross sale proceeds and 10% capital gains, and remitting the $40,000, would the same 20% tax rate apply to the capital gains portion (10% * $40,000 = $4,000) as well as the non-capital gains portion (90% * $40,000 = $36,000)? What would the math look like in this specific scenario?
4. I've addressed this in the other comment, but nothing is remitted in a Roth Conversion by design. If it were, it'd have to be triggered outside the conversion process, and doesn't make much sense from a financial perspective.

 

[twhi]

@babytomato

1. See my other reply explaining that the income tax laws deem remittances to be from foreign income sources for the purposes of income tax. This is not something you can avoid, except if you do not send any money to Japan from any source whatsoever.
2. If you become a nonresident status for income tax purposes (see the wiki for how residency is determined), you will only be taxed on Japan source income. Any gains from US stocks realized as a non-resident would not be taxable in Japan.
3. NPRs are not taxed on remittances, rather they are taxed on remitted income. Capital gains income is the sale price in yen minus the purchase price in yen. So you would not be taxed on $40k. You would be taxed on the portion of the $10k gains that were remitted to Japan.
4. See my other comments about how the Japan income tax law deems remittances to be from foreign income sources for the purposes of income taxes. Therefore it doesn't matter whether the Roth conversion was remitted Japan, it just matters that any funds (from any source) were remitted to Japan in the same tax year as the conversion.

 

[babytomato]

@twhi

Therefore it doesn't matter whether the Roth conversion was remitted Japan, it just matters that any funds (from any source) were remitted to Japan in the same tax year as the conversion.

OK, so if this is true, then this is a new critical detail that I've found nowhere else in my research. My read of this is that if I transfer any amount of cash from my brokerage to JPY in a given tax year, then all the capital gains in my brokerage become taxable in the same tax year, regardless if the gains are from assets that I purchased before I was NPR.

**Is that true for unrealized gains as well?** Does this happen at the granularity of accounts within a brokerage, or is the granularity at the brokerage (institution) level?

If so, then I think an alternative course of action - rather than investing the $40,000 for the first year in Japan, then selling it off to fund the second year - would be:

• Put 2 years of JPY in my Japanese bank account before arriving in Japan
• Capital gains harvesting on stock that I purchased before becoming NPR at the end of year 1 in Japan
• Roth Conversion at the end of year 1 in Japan.

This means that I wouldn't use any stock sale proceeds from my brokerage at the end of the first year to fund my second year in Japan. The advantages are:

• Tax-free capital gains harvesting in both U.S. and Japan
• Tax-free Roth Conversion in both U.S. and Japan
• Simpler tax calculations

The disadvantage is the loss of 1-2 years of growth potential for the $40,000.

I still think investing is a better approach than this, since I'm only taxed on a portion (20%) of the capital gains.

Another option is not to do any capital gains harvesting at the end of the first year. So I'd only be taxed on whatever the realized gain on the $40,000 sale was, which could be fairly modest depending on the 2024 return on investment.

 

[twhi]

@babytomato

Put 2 years of JPY in my Japanese bank account before arriving in Japan

You won't be able to open a Japanese bank account as a nonresident. So unless you already have an active Japanese bank account from a previous residency, this won't be possible.

 

[babytomato]

@twhi What I meant was in my credit card, or JPY account, which uses local banks as a proxy. Something like Wise or Revolut.

 

[twhi]

@babytomato I’m not familiar with how that works. Maybe someone else can comment on whether that counts as remitting to Japan prior to establishing residency. @kristhuy, do you know?

 

[kristhuy]

@twhi If @kybim-Mammoth's Wise account is maintained by Wise Payments Japan K.K., then transferring JPY to the account should count as a remittance. The same applies if their Revolut account is maintained by Revolut Technologies Japan, Inc.

But in general, both Wise and Revolut will refuse to allow a non-resident to open an account maintained by their Japanese subsidiary until the account-holder has provided proof of Japanese residence. So I doubt the kind of transfer OP is describing would constitute a remittance.

 

[babytomato]

@kristhuy In the end I decided to move 2 years worth of living expense (plus some buffer) to my JPY Wise account before moving to Japan, without any further remittances from the moment I set foot in Japan.

I believe this means that I won't have any tax liability in Japan when I do capital gains harvesting and Roth Conversions because I'm not remitting any proceeds to Japan from these two transactions (or any other foreign sources), and also none of the stocks I own, which I'm resetting the basis for, were bought while I was a tax resident in Japan.

After two years, we'll reconsider if we'd like to stay and accept the added tax liability or move somewhere else. If we stay, we'll remit from selling stocks. But at least at this point, the taxable capital gains would be starting from a less stale cost basis slate.

 

[kristhuy]

@babytomato

to my JPY Wise account

Is your account maintained by Wise Payments Japan K.K. though? If you don't have proof of Japanese residence, it's unlikely that Wise Payments Japan K.K. will be willing to handle your funds.

 

[twhi]

@babytomato

I'm also curious to hear from any Americans that have achieved FIRE in Japan. 20% of capital gains proceeds can be pretty big, so I'm wondering how folks make this work in the long-term. Maybe it's worth it when comparing Japan's quality of life to the U.S., even if one can pay zero taxes the U.S. (both capital gains and income tax) when FIRE.

A long term visa is required if you want to live in Japan long term. A student visa won't get you there. And there is no retirement visa. So unless your spouse is Japanese or you have Japanese heritage, your only choice is to come on a work visa and try to eventually get permanent residency. So you'll have to postpone your early retirement.

As to the taxes being higher than the US, think of it as part of the cost of living. So ask yourself if you have enough to retire given the cost of living. If the answer is no, you'll need to work longer to save more for retirement if you want to retire here. Putting this together with the paragraph above, you can solve your income problem by working long enough to get permanent residency.

By the way, 20% capital gains tax is not that big when compared to tax at marginal rates. It's only big when compared to your strategy to pay no taxes in the US.

 

[babytomato]

@twhi I'd planned on working on an HSP here initially, but I've just realized that I like the freedom that comes with not working. Maybe my perspective will change within two years.

By the way, 20% capital gains tax is not that big when compared to tax at marginal rates. It's only big when compared to your strategy to pay no taxes in the US.

Indeed, the jump from zero to 20% is likely what's bothering me. If I already had to pay capital gains tax in the U.S., it wouldn't really be an issue. I don't like the prospect of being taxed on distributions from U.S. tax-advantaged funds, though.

Financially the amounts likely wouldn't make a big difference, but it's a headache and time-consuming to figure out tax nuances.

 

[risenart]

@babytomato Following

 

[babytomato]

Regarding Roth Conversions (question 4), this was asked on Ben's podcast 8 months ago: https://www.youtube.com/live/iuZiI9E2Nvg?si=Fhkfu114FEgMpIBL&t=3531

It seems that if you're NPR, you wouldn't be taxed on the conversion, unless you remit the money to Japan. But remitting would defeat the purpose of the conversion, so this scenario doesn't really make sense.

Once you're a tax resident and no longer NPR, then you have to pay taxes on it as global income, regardless of the fact that it's tax-free from the U.S. perspective.

 

[twhi]

@babytomato As mentioned in my other reply, remitted income is defined in Article 17 of the Order for Enforcement of the Income Tax Law. This means that any funds remitted to Japan (including from use of foreign credit cards in Japan) will be considered to be from income sources, regardless of the specific account the funds came from. So the only way to avoid remitting the income (from the Roth conversion or any other foreign income) would be to avoid sending any funds to Japan in the same tax year as the income.

 

[babytomato]

@twhi To clarify my original point: I'm pretty sure that by design, there's no way to remit money from a Roth Conversion in the same tax year that the conversion was performed, making this tax-free from the U.S. as well as the Japan perspective for NPRs. Or at least, remitting money wouldn't make financial sense for anyone doing a conversion.

A Roth Conversion moves money from tax-deferred retirement vehicle (i.e. Traditional IRA) to a tax-advantaged retirement vehicle (i.e. Roth IRA). In practice, you fill out a form with your brokerage, specify the amount you want to convert, and they move the money between accounts for you. You then have to pay U.S. taxes up front (same tax year as the conversion) on the converted amount. It's done as a hedge that taxes now will be less than taxes at withdrawal time (many years into the future), and for other subtle reasons. It also does make the converted money more liquid - can be withdrawn at

min(5 years after conversion, 59.5 years old)

- but there's no way to remit any of the converted money to Japan.

I suppose you could simply withdraw the converted amount (with an early withdrawal fee) from the target tax-advantaged account, but that's unrelated to Roth Conversions as such (you may as well have withdrawn the unconverted amount as you're paying U.S. taxes on it either way).

 

[twhi]

@babytomato Your reply states that "there's no way to remit any of the converted money to Japan". This shows a fundamental misunderstanding of how the income tax law determines that foreign source income has been remitted to Japan.

You need to throw out any preconceptions about what it means to remit income and try to understand the legal definition in Article 17 of the Order for Enforcement of the Income Tax Act.

This subreddit's wiki page on income tax gives a good practical explanation: "Income that would otherwise be classified as foreign-source can become taxable in Japan to the extent you remit money into Japan in the same year the foreign-source income occurs. Note that it does not matter whether the money remitted into Japan comes from the foreign-source income that occurred that year or some other source like savings acquired in previous years. It only matters that while you are NPR status, foreign-source income and a remittance into Japan happened in the same year."

So this means that for the purposes of Japan income tax, you can't control which money you remit to Japan. The income tax law deems the remitted money to come from your foreign source income for income tax purposes, even if the remittance was from an unrelated savings account.

Therefore, the only way to avoid remitting income is to not remit any money to Japan in the same year as you had foreign source income (in this case, the rollover).