Questions? Thoughts? Send a Text to The Optometry Money Podcast!
As we get into the holiday seasons and end of the year, it's time for a rewind of a popular 2022 episode on managing taxes through capital gains!
Evon continues the year-end tax planning theme and talks all about how investment income and capital gains impact your tax return.
He dives into how your investment account creates income, how it's taxed, and 5 levers you can pull to control capital gains on your tax return. This episode is a great example of how all the different parts of your finances - investments, taxes, charitable donations, cash flow needs - are all intertwined. You should look at them together when making financial decisions.
Have questions on anything discussed or want to have topics or questions featured on the show? Send Evon an email at evon@optometrywealth.com.
Check out www.optometrywealth.com to get to know more about Evon, his financial planning firm Optometry Wealth Advisors, and how he helps ODs nationwide. From there, you can schedule a short Intro call to share what's on your mind and learn how Evon helps ODs master their cash flow, build their net worth, and plan purposefully around their money and their practices.
Resources mentioned in the show:
The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.
The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.
Questions? Thoughts? Send a Text to The Optometry Money Podcast!
As we get into the holiday seasons and end of the year, it's time for a rewind of a popular 2022 episode on managing taxes through capital gains!
Evon continues the year-end tax planning theme and talks all about how investment income and capital gains impact your tax return.
He dives into how your investment account creates income, how it's taxed, and 5 levers you can pull to control capital gains on your tax return. This episode is a great example of how all the different parts of your finances - investments, taxes, charitable donations, cash flow needs - are all intertwined. You should look at them together when making financial decisions.
Have questions on anything discussed or want to have topics or questions featured on the show? Send Evon an email at evon@optometrywealth.com.
Check out www.optometrywealth.com to get to know more about Evon, his financial planning firm Optometry Wealth Advisors, and how he helps ODs nationwide. From there, you can schedule a short Intro call to share what's on your mind and learn how Evon helps ODs master their cash flow, build their net worth, and plan purposefully around their money and their practices.
Resources mentioned in the show:
The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.
The Optometry Money Podcast is dedicated to helping optometrists make better decisions around their money, careers, and practices. The show is hosted by Evon Mendrin, CFP®, CSLP®, owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide.
Hey everybody as we get into the holiday seasons and towards the end of the year, I wanted to replay a popular 2022 episode, all about managing taxes around capital gains. And hope you enjoy the episode, and we will catch you next time. Hey everybody, welcome back to the Optometry Money Podcast, where we're helping ODs all over the country make better and better decisions around their money, their careers, and their practices. I'm your host, Evon Mendrin, Certified Financial Planner and owner of Optometry Wealth Advisors, a financial planning firm just for optometrists nationwide. Thank you so much for listening, hope you all had an awesome Thanksgiving. Um, and on today's episode, we're going to continue that end of year tax planning conversation. And specifically today, we're going to talk about the income that's generated from your portfolio, your investments, and especially capital gains and how that impacts and influences your tax return. And we'll talk about five levers, five levers that you have to control how capital gains and your portfolio income impacts your tax return towards the end of the year and beyond. So first, I just want to start with a kind of a general broad overview of how. portfolio income is taxed, how income inside of your investment accounts are taxed. And for this conversation, I'm just talking about a taxable investment accounts, not talking about retirement accounts like your 401k, your Roth IRA, or, um, in general, a health savings account, an HSA. Um, those accounts, when you invest and create income inside of retirement accounts, That income doesn't end up on your tax return every year. Uh, it just stays within that retirement account bubble. And depending on the type of account it is, when you withdraw is usually how, uh, how taxation occurs. But with a regular taxable brokerage account, so, uh, any taxable investment account, you can open up at, um, Schwab or Vanguard, Fidelity, or like a living trust account. Uh, those accounts are where Income matters, taxation matters when it comes to what goes on inside of your investment account because any income created in that account shows up on your tax return in that year. So let's start with a general overview of how income is created in these accounts. and how it's taxed. So let's start with the very basics. Um, inside of your investment account, you may hold individual stocks, right? So stocks are partial shares of ownership in a corporation, uh, could be in the U. S., could be internationally, and that stock may or may not pay a dividend. So, basically, it's just taking out of, uh, earnings and passing on cash to shareholders, so that stock may pay a dividend to you that's going to show up as cash in your bank account. Or you may choose to have it reinvested, you know, whatever, whatever you're choosing to do with that, uh, that dividend. But, um, one way of income's generated is going to be a dividend from a stock. Another way income's generated is going to be... uh, from a bond. So a bond is essentially debt. When you buy a bond, let's say you're buying it directly from a corporation or directly from a government, uh, you are lending that money to the corporation or the government. In return, you're going to get interest. And then, uh, when that... Bond, it matures. When it ends, you're gonna get your principal back, right? So you're gonna get interest income, uh, from a bond. Um, and then there's also something called, so that's income. And there's also something called a capital gain. And what that is, is that if you sell an investment. For a higher price or higher value than you bought it at, that difference is a capital gain. For example, if you buy a stock for 10, you sell it for 20, that 10 difference is a capital gain and that capital gain is considered income. If it's in one of these regular taxable brokerage accounts and that income is going to end up on your tax return. And, uh, and how it's taxed depends on how long you've had it. And, uh, another part of that is called a cost basis. So the cost basis is the amount that you originally buy this, the stock at. Your initial investment, right? So in that example, That first 10, 000 is your cost basis. That's not taxed. If you sell it, only that difference, that gain is, is considered income. So there's something called a capital gain, and that's created when you sell something at a higher amount than you originally bought it. And that's also the same with other assets outside of an investment account, like a private practice sale or, or a rental property. Uh, those are governed by the same general capital gain taxation, guidelines. There's some differences which, with those different assets, but in general, it's the same, the same concept. What about, so those are with individual stocks, individual bonds. Uh, what about with mutual funds or ETFs because a lot of us will invest with mutual funds or ETFs, exchange traded funds, and so how do those work? Mutual funds and ETFs are just baskets of investments inside of it, right? So you're investing in this fund, in this mutual fund, and inside of the mutual fund are a bunch of different investments, a basket of investments. And it could be stocks, if it's a stock mutual fund. um, it's going to be a basket of a bunch of stocks. If it's a bond mutual fund, it's going to be a basket of a bunch of bonds. And when those investments inside kick off income, like if the stocks that the mutual fund is invested in, if those stocks kick off dividends, the mutual fund is required to pass that net income off to you, to the shareholder. So that mutual fund, or ETF, is really more of a conduit. It's, it's passing on whatever income is generated from these investments onto you. And it's going to end up on your tax return in the same way that those underlying investments created them. So if a stock mutual fund kicks off dividends, it's going to end up on your tax return as a dividend. If a bond mutual fund kicks off interest, the bonds underneath create interest. It's going to end up as interest income. on your tax return. So that's going to determine its taxation. What about capital gains? Uh, well, capital gains, uh, can work one of two ways. Uh, number one, you can sell the mutual fund or the ETF at a higher value than you originally bought it at. Uh, and that's how you can create a capital gain. But something else can happen when you are invested in a fund managed by someone else. And that the manager managing the fund on your behalf. uh, within the mutual fund, buys or sells things depending on whatever the fund needs. And those, those purchases and then sales can create capital gains within the fund. And at the end of the year, if there's net capital gains to, uh, created within the fund, that mutual fund is going to pass on those gains onto you, the shareholder, right? So, so you're going to see those capital gains end up on your tax return as well. REITs, REIT investments, REIT funds, Real Estate Investment Trusts, so mutual funds that hold a bunch of REITs underneath, or, or an ETF that owns a bunch of REITs underneath. That works in much of the same way as a mutual fund. It's required to pass on, the vast majority or all of its income, uh, onto to you, the shareholder. So we have, uh, dividends, we have interest, and we have, uh, capital gains. And how is all that income taxed, right? So that's how it's created. Now, how is it all taxed? Uh, well, it depends on the type of income you have. and how long you've held the investment. So let's start with capital gains. Capital gains are taxed based on how long you've held the investment that you're selling. If you've held an investment for longer than a year, right? So for a day over a year and beyond, the capital gain that's created from that sale is going to be a long term capital gain. And long term capital gains are taxed more favorably at more favorable tax rates. then all of the rest of your income. So when we think about your salary, um, profit from the business, self employment income, net rental income, all of that is what we would call ordinary income. And that's taxed at those, those tax brackets that you're familiar with, like 10%, 12%, 22, 24 and beyond. And so those are your ordinary income, uh, federal income tax brackets. However, long term capital gains are taxed more favorably. There's a sec, a separate tax bracket specifically for that. And it's going to be taxed at either 0%, 15 percent or 20%, depending on where your taxable income is. Just like your other, your other, uh, all of your other income. It's just, it's going to have a more favorable, um, tax rate applied to it. And what about if you own that investment for shorter than a year, right? So for 365 days and less, that's called a short term capital gain, and that's taxed just like the rest of your income, right? It's taxed at those less favorable, higher tax rates that your salary and everything else is going to be taxed at. So you have long term capital gains that are more favorable if you own it over a year and beyond, and short term capital gains. So that's, that's how capital gains are taxed. And the same thing with losses too. So if you sell an investment at a lower price or value than you originally bought it, you have a loss. You can have short term losses and long term losses. And we'll talk about why that's important later on, but that's capital gains. And the tax rate, uh, for capital gains can also include one more bit of tax called the net investment income tax. And that is another 3. 8 percent tax on your investment income like capital gains in addition to that 0 to 15 to 20%. And that extra 3. 8 percent tax kicks in if your AGI, your adjusted gross income, is over 250, 000 if you're married. Uh, over 200, 000 if you are single. and over 125, 000 if you are married but filing separately. So if you are going for a type of student loan forgiveness, for example, and you're planning requires you to file taxes married separately, that's something for you to keep in mind. So, uh, so there's an extra amount there. Based on your income over those thresholds. And so your, uh, the reality is your, your long term capital gains can be taxed at, uh, 15, you know, 18. 8 percent up to 23. 8%, right? So those are the real, the real, uh, taxation that you're looking at there. What about dividends? There's two different types of dividends to keep in mind. One of them is qualified dividends. Qualified dividends are going to be domestic corporations. So those in the U. S. that meet a certain criteria, right? So there's certain, certain criteria to follow. You're going to find a lot of your U. S. mutual funds will kick off qualified dividends. Qualified dividends are taxed just like those long term capital gains. It's better stuff. It's taxed at those more favorable tax rates. In general, when you hear like qualified income, when it comes to this portfolio income, this portfolio stuff, it's taxed at those better tax rates. Non qualified dividends or interest income from bonds or bond mutual funds, those are taxed like all of your other income, right? So that's going to get those higher tax brackets. So that's how dividends are taxed. Uh, the qualified stuff is the, the more favorable stuff. REITs, Real Estate Investment Trusts, so funds or ETS that hold REITs. that income is gonna be based on what type of income they're passing onto you. So if they're dividends from profits within the REIT from, uh, from like rental income, things like that. Uh, from net profit, are taxed as ordinary income just like the rest of your income, right? So, not, not as favorable, but just like a mutual fund you can get. capital gains within the REIT. If they're selling properties, you can even get a return of your capital. So, uh, you'll, you want to look at that, but, uh, by default, it's taxed as ordinary income from profit. But there's one thing that kicks in here with REITs specifically is that, uh, through at least 2025, you can get a 20 percent qualified business income deduction on qualified REIT income from profits. Right, so, you know, qualified REIT dividends from profits. So, uh, this 20% QBI deduction, this is usually something you'd only see if you own a private practice or if you're doing independent contractor work or you're self-employed in some other way. But this is something that applies to, uh, to REIT income as well. So that's pretty cool. So if you have a taxable investment account, you'll see this income end up on your tax return. You're going to see it on the first page of your 1040, which is your main independent, your main individual tax return. Uh, you'll see a spot for dividends and qualified dividends. You'll see a spot for, um, capital gains. And then if you look at the schedules, you'll see, if you want to learn more about where that's coming from, you can look at schedule B. That's going to show you interest in ordinary dividends. And then schedule D, it's going to show you capital gains. Uh, one question I get is, is how does this actually work on your tax return when you're combining all this income together? Because we're talking about two different types of income, uh, the ordinary stuff and the more favorable qualified stuff with two separate tax rates. Like how does that work when you combine it all on your tax return? Well, the best way I've thought about this, uh, or been able to figure out a way to explain is that You know, think of your taxable income as, as a big pile of income. And each layer of that pile is taxed at different tax rates, right? So the lower part of the pile is taxed at lower tax rates. The higher part of the pile is going to be taxed at those higher tax rates. And, and on one side of the pile, you're going to see the regular tax rates that you're, you're familiar with. 10, 12, 22, 24 and beyond. And then on the other side, you're going to see the more favorable stuff for that different type of income. 0%, 15%, 20%. And so when you look at this pile of income and you're combining your salary and you're combining long term capital gains and all this different, all these different types of stuff at the top of this pile is always going to be. the long term capital gains or qualified dividends. The qualified stuff, the more favorable stuff is always going to be at the top of the income pile. At the bottom of the income pile is always going to be the ordinary stuff. Your salary, business profit, uh, self employment income. uh, non qualified dividends, short term, uh, capital gains. All of that higher tax stuff is going to be at the bottom of this pile of income, and the more favorable stuff is going to be at the top. And so as income grows, it's going to push that whole pile up, which means more of it's going to be subject to tax. But the top of that, where the highest tax rates are, is going to be your, your more favorable, qualified income. And at the bottom of that, where the lower tax rates are, is going to be your... your ordinary, more highly taxed income, which ends up working out in your favor, because even at the higher tax brackets, the long term capital gains and the qualified dividends, that qualified stuff is taxed at a more favorable tax rate than your higher tax brackets on the other side, your ordinary stuff, right? So I, as I'm explaining that, I'm not sure that's, that's making total sense on a podcast vocally. So I think this is a blog post I'm going to want to put together with some graphics here, but just think of your taxable income as a pile. The favorable stuff is always going to be on the top. The less favorable stuff is going to be on the bottom. Let's think of it that way. So that's the very basics of how that income is created and how it's taxed. Now, how do we control? How To Get Your Income From Your Portfolio, um, especially as we head towards the end of the tax year. How do we start to plan and control this income so that it doesn't impact your tax return, um, overly, in an overly negative way or in a surprising way, and then even beyond this tax year. And remember we're talking about taxable investment accounts, not retirement accounts, right, that's a totally different subject. So how do we start to control that income? I'm going to talk about five different levers that you can pull to start to control, especially capital gains, uh, within your tax return. So, the first tax planning lever for capital gains is going to be, uh, be careful of the type of investments that's in the taxable investment account, right? So take a look and watch out for what type of investments and what category of investments. are inside of that investment account. The reason why is because that's going to dictate what type of income is created and that's going to show up on your tax return. So for example, be careful about owning bonds or bond mutual funds or ETFs in a taxable account unless there's a specific purpose for it. The reason why is because interest income is taxed at the same tax rates as All of your regular, ordinary income. So, it may make sense to instead hold stock mutual funds, or ETFs, uh, since dividends are likely to be qualified dividends, and taxed more favorably, or long term capital gains, um, so you'll have, uh, potentially more favorable taxation on that income. There's some international considerations too for international funds. For example, the foreign income tax credit. So there's some things to think about there. But in general, it may make sense to hold stocks instead and keep an eye on whether you own REITs within that account and see how the REIT income is taxed. If there does need to be bond funds, I think about whether it makes sense to own municipal bond funds inside of the account instead of regular corporate bond funds. So for example, if you, your goal for this investment account is a shorter term goal and you want to have a little bit more bonds, uh, those more stable type of investments to, to lower that short term uncertainty there, see what type of bond funds actually make sense. And the reason is because municipal bond funds. The interest income from that is not going to be taxed federally. It's not going to be taxable income on your federal tax return in general, in general. There are some places where that's pulled back in and, and, uh, taken into account. Uh, very specific situations, but generally speaking, it's not going to be federally taxed interest income. Uh, in some states, if you own municipal bonds for the state that you live in, like in California, it may not be taxable in the state either. So take a look at that and see whether it makes sense to own municipal bonds based on the interest yield and your income. There's a formula you can check out called the after tax yield. Basically, it tells you and helps you calculate, uh, does a regular corporate bond fund, pay enough interest after taxes to make sense instead of a muni bond fund. So you can google that, take a look at that, uh, that'll help you sort of calculate that. Another thing to look at is how much capital gains and income in general, but especially capital gains are created and distributed and passed on to you from the mutual fund or ETF. Um, generally speaking, more actively traded mutual funds. So actively managed mutual funds with an active investment strategy are going to have a higher capital gains embedded in them and likely passed on to you. Since there's generally more trading in the, in the mutual fund, there's more buying and selling happening to account for that. trading strategy, right? There's an active manager carrying out a strategy. In general, there's going to be more trading happening. Generally speaking, more passive style investments like index funds or similar investments tend to have less capital gains kicked off because there's a lot less activity happening. And, and so take a look at what type of mutual fund, uh, is in the account. And, and. Take a look at how much capital gains is being created and passed on to you, especially funds, whether they're passive or not, where a lot of people are leaving the fund within the year. Because when people leave a mutual fund, The fund manager may have to sell shares of the investments if there's not enough cash to give back to the people that are selling, right? So, uh, to give back to those old shareholders. So, um, so take a look at that too. Keep an eye on that. This is one reason why I always say ETFs, exchange traded funds, are, uh, tend to make more sense in a, um, in a taxable investment account because of the way that ETFs are structured, and we're not going to get into it. Right now, but maybe you can take a look at, at, uh, at Googling this. But the way the ETFs are structured, uh, basically means that there, there tends to be a lot less or even no capital gain distributions at the end of the year. Um, some, some funds you can look at the, at one mutual fund and they may, and that, that mutual fund company may have an exact same ETF invested the exact same way. The mutual fund will have taxable gains to distribute at the end of the year and the ETF will not. So, ETFs, generally speaking, again, tend to be more tax efficient than mutual funds, although there are tax managed or tax advantaged mutual funds that can work well too. But take a look at that as well. What are you owning in these accounts? And for do it yourselfers out there, Morningstar has a helpful website. You can learn a lot by looking at the turnover percentage of a fund, which tells you about how much buying and selling is happening over the year, and which can give you a clue of how much capital gains can be created and passed on. And they even have a tax cost ratio for you to take a look at and reference as well. So Morningstar is a fun, helpful website. Also take a look at your last tax return. You know, generally this is where I pick this stuff up, is by starting and looking at the tax return of a client when they come in, um, how much income in general, but how much capital gains are kicked off and end up on the tax return. How much of that's short term capital gains versus long term capital gains. So that's something I'll look at too by looking at the tax return. And so the action item here is really to take a look at, at your account, keep in mind what the purpose of it is and how it should be invested, how much should be in stocks versus bonds, uh, but then try to put the, the best, most tax efficient investment in that account based on your, your overall investment goals. Uh, we in the biz, the financial advisory business. We call this tax location, meaning that we look at all of your different accounts, because your taxable investment account is, is a piece of a larger pie, right? If it's, if it's, uh, meant for long term financial independence, if it's a long term investment account, it's one part of all of your accounts going towards that same goal. You 401k, Roth IRA, HSA, whatever it is, right? So we want to look at all these different accounts. And we wanna see where does that taxable investment account fit in? And we wanna fit the best type of investment category in each account based on how that investment is going to be taxed and how that, um, how that account is going to be taxed. Right? So that's just putting the right, the most, uh, favorable, appropriate investments in the most favorable account. We call that tax location. So that's, that's an action item to just take a look at. what's being owned in your account, how much income is being created from it, and can that be improved. The second lever to pull is to be mindful of selling investments, especially late in the year. And let's say you need to sell mutual funds or whatever it is in your account because you need to make cash. If you have options in the account, meaning you have more than one fund, uh, be careful about which of those options you're selling, uh, in fact, even be careful about which specific lots or shares that you're selling. Take a look at whether they're short term or long term capital gains. Uh, how does your custodian track, track the cost basis? You know, there's different ways that they'll track that. And then can you, for example, can you sell, uh, uh, a mutual fund that's more tax favorable? and then rebalance in another account like a 401k, right? So take a look at it, at the tax consequences of doing that, because you want to be aware of if you're creating a capital gain, especially late in the year, how does that impact your taxes as a whole? What are the tax consequences of that? This is where a good tax projection comes in handy. This is where I'm reviewing these tax projections late in the year, taking a look at some of these things, trying to keep into account what are our cash needs. uh, late in the year. Can we push off sales into the beginning of next year? Uh, because what you don't want to have happen is that you create some income, a capital gain income, and it increases your income enough to where you're starting to phase out on deductions, or your, so certain credits are lowered, or, uh, more income is pushed into a higher tax bracket, for example. So you just want to be aware of what tax consequences, uh, you're creating when you're selling things for a gain, um, towards the end of the year. Uh, the third lever to pull is to be careful when you buy mutual funds or ETFs in December. Why? Because December can be the biggest distribution, the biggest passing on of income to you, because it's going to have dividends or interest, and especially for stock mutual funds, and capital gains, right? And for some mutual funds, they only distribute once a year instead of like quarterly or monthly. So this is the big one in December. So watch out for buying something, especially at a high dollar amount, mid to late December. Specifically, you want to look at the record date. which is, uh, the date that You would be on record for owning that fund and responsible, or, uh, you get access to that income, right? They're gonna, they're going to distribute that income to you because you're on record. So check with your mutual fund company right now. They're usually going to have all these public, um, they usually have a list of all their funds, how much income and what type of income is distributed per share, when the record date is, and when the actual distribution date is. And, uh, this is, again, this is usually happening. Um. Mid to late December, keep an eye on that. One weird thing that happens with this when, when these funds distribute a lot of income is that it just so to, to keep in mind for yourself is that when they distribute the income, they send cash to you, which means there's less cash in the fund. And that means the value of the fund decreases. It declines, right? Because there's literally less assets in the fund. And a lot of times, you know, people will call and say, wait a minute, how did we, how did we have all this negative performance? Like what, what happened in one day? Basically, all that happened was that is that they distributed cash to, to the shareholders and the value of the fund declined simply because there's less assets in the fund, right? So, so that'll happen. Uh, keep, just keep that in mind, but that's the third lever you can pull is Be mindful of when you're buying these funds, especially at high dollar amounts. You can wait a day or two and still buy the fund and avoid all that income. The fourth lever that you can pull is called tax loss harvesting. And this is a big one. What is tax loss harvesting? Well, tax loss harvesting is simply selling an investment at a loss, right? So if you bought it at 10, You sell it for five, you've sold it at a loss, and then immediately purchasing another investment, a replacement investment, right? So this is not a, an investment timing idea, where you're not trying to time the market, jump in and out. Uh, you are selling it just to book the, uh, the loss. on your tax return. This is entirely for taxes. And then immediately buying a replacement security. And, uh, and when you create capital losses, those losses can offset other capital gains. So, for example, if you sold other investments earlier in the year before the market, uh, declined this year, and also bonds declined this year, uh, if you sold something earlier in the year and it created a capital gain, well those capital losses can offset those gains. Right, that'll, it'll eat them up, it'll gobble them up. And there's a certain way they do that. So if you have short term losses, meaning you sold things that you own less than a year, those will first offset short term gains, right? So those net first, long term losses, net against long term gains, right? So there's a way that this happens. Uh, but it, uh, all of your losses can offset your gains, or even if you sold like a rental property or, uh, or your optometry practice, right? That, that can help with that. Uh, if there are extra losses above any gains that you had, so let's say you. You created 3, 000 of capital gain. And then you sold... You sold investments for a 6, 000 loss, right? So, uh, the 3, 000 gains are eaten up by 3, 000 losses. That, that leaves you with 6, 000 of loss, or I'm sorry, that leaves you with 3, 000 of losses. That can be, uh, up to 3, 000 of capital losses. can be deducted against all of your other income on your tax return. So that can provide you a, um, a pretty cool 3, 000 tax deduction that you, you normally wouldn't be able to get, right? So that's, that's a pretty cool, uh, pretty cool feature. Um, if you have any additional losses above and beyond that 3, 000 per year, Those losses just carry on, uh, into future tax years until they're used up, right? So you'll have, uh, you'll have carryover losses going into the future years. So the benefit there is that you can, you can offset some capital gains and you can get a, um, a three, up to 3, 000 deduction against all your, your other income on the tax return. So that's the whole point of tax loss harvesting. There are some things to keep in mind. It's not always worth the effort and the time, and there's some rules and risks to think about in order to do this right. So the first rule to keep in mind with tax loss harvesting is that you want to watch out for the wash sale rule. And the wash sale rule means that whenever you sell something for a loss, If you buy in a substantially identical investment, either 30 days before or 30 days after, those losses are, are voided, right? You cannot use those losses on your tax return for whatever dollar amount you're, you're buying it back for. And... uh, this includes other accounts too, right? So if you, if you buy it in your IRA, but you sold it in your brokerage account, well, that technically counts towards this wash sale role within this 61 day window. So you want to be careful about what you're buying and selling 30 days before and 30 days after you're doing this. And then you want to plan carefully for how you're going to get back into that original investment. If you're going to. So what is a substantially identical investment? Well, there's no clear guidance on this. It's actually a little bit vague, uh, by the IRS. Um, so you kind of have to use your, your, um, your, uh, tax pro and advisors, you know, financial advisors guidance here and your, your best, uh, wisdom here. Um, and we can safely say that if you sell a individual stock and you buy the exact same individual stock, that's substantially identical, right? So identical securities are identical. What about mutual funds or ETFs? What is a common practice is that If you are selling a, uh, one index fund, for example, at a loss, and you're buying another index fund that's the same category, but tracks a different index, that is, uh, not substantially identical, right? So two index funds, for example, that track, that are within the same category, say within, uh, within large cap U. S. stocks, but one tracks, uh, the S& P 500 and one tracks the Russell index. Uh, common practice is that would not be substantially identical and that is Uh, that is going to work for this, right? It's not going to trigger this wash sale rule. Uh, if you buy, you know, typically speaking from common practice is if you buy, if you sell one S& P 500 fund and you buy another S& P 500 fund, even if it's from, even if it's from a different company, you know, for example, Vanguard One, Fidelity Another, that is in common practice substantially identical. So just be careful about which ones you're buying and selling. Uh, there are some ways we've worked around this with clients over the years. You know, just keep an eye out for this wash sale rule and just be careful about how you're planning to get back into your original investment if you can. Transaction fees are another one. So if you're buying and selling mutual funds, there's going to be some, uh, there may be transaction fees to do that, uh, depending on where, where you're doing that, um, out of market risks. So if you are selling an investment and then waiting the 30 days to get back into it. and that's just sitting in cash, you may very well miss out on the gains that come within those 30 days, right? Uh, that can even happen overnight. There may be a risk of, uh, you sitting in cash for a day or two. You know, even overnight, the, the market can swing enough to make that tax, uh, benefit, uh, not worth it. And we've seen, I mean, we've had conversations, I know my Some of my ex co workers and peers have had conversations with clients where, uh, they're looking at it and saying, man, it would have to be a substantial increase for, for this to not make sense. It's possible, but it would have to be something that we're not typically seeing on a daily basis. And then that happens, right? So, and then that exact swing happens and you sort of have to be aware that that's a possibility. So. Um, watch out, there's always a risk when you're out of the market and sitting in cash when you mean to be invested. Uh, just keep that in mind. And another thing about tax cost harvesting is that it, it, it resets the basis on the investments that you sell. So, let me explain what that means. So, let's say you have an investment and it, it drops 5, 000, right? So, it's, it's at a 5, 000 loss. You have 5, 000 of room for it to recover before you, you have a gain if you sell it again, right? It would have to recover that 5, 000 just to make even, and then after that you would have a capital gain if you sold it, right? So you've got all that extra room, and then gain after that. Well, if you've sold that investment for a loss now, and then you, you book the loss on your tax return, and then you purchase another investment right away, the minute you sell the investment for a gain after that... You now have a capital gain, right? So you've reset that cost basis, added on extra gain, I guess is another way to say that, right? So, when you do this, you need to be sure that that makes sense to use that loss, reset that cost basis, and add a more potential capital gain down the road. And then when you do this and you sell right away, it's now at a short term capital gain. Whereas before, if you waited for it to recover and then sold after that, it may have been at long term capital gain, right? At more favorable tax rates. So that's something you need to keep in mind. It's not always worth doing, but it often, it often can make sense. So when does it make sense? Well, if you have a pretty substantial loss in terms of dollar amounts or percentage to where, uh, the tax benefit will make sense, right? If it's a small little, little loss, you don't want to go through that time and effort for that. And you want to make sure you have an appropriate replacement, right? You have something else to invest in, or you have a plan to get. you'll be able to get all of your income back into your original investments, you're not going against the rules, and it's not going to be sitting in cash forever. If there is no alternative, and it's just going to be sitting in cash, well that doesn't make sense, right? From an investment standpoint, it can make sense if you are able to get that 3, 000 deduction, why? Because you can get a deduction against your ordinary income, all of your other income at those higher tax rates. and then down the road you can sell this the same investment far down the line at more favorable long term capital gains tax rates, right? So that sort of tax trade off arbitrage works out. If you're rebalancing, for example, if you need to rebalance anyways and trim one category of investment so you can reinvest into another, or if you're trying to get rid of something you've been trying to get rid of anyways that doesn't fit, maybe you have a really expensive, actively managed mutual fund that you've been trying to get rid of. And now it's at a loss. Well, that's, that's an opportunity to, to reinvest, uh, reinvest those dollars without a, a major tax hit. It can make sense if you are trying to offset capital gains that you've created in the year, especially if you are at among the highest tax brackets, right? So if you're at among the highest tax brackets and you're trying to offset, um, some of that gain with losses, that can make sense. especially if you're expecting to, uh, to be in a lower tax bracket later on in retirement. If you're able to sell these investments later on at those lower tax rates, uh, that can make sense too, but it doesn't always make sense. There's a very small, slight tax benefit. Um, especially in relation to like what you can miss out on, on market swings. Um, if you don't have a good alternative, uh, if you're never planning to sell the funds and they're just going to be inherited, that may not make sense at all. Uh, or if you're planning to donate the funds to charity in this tax year, that may not make sense. And we'll talk about that in the next, the next, uh, lever here. And then if you're planning to sell within the next year anyways, that may not make sense because what would have been long term capital gains is now short term, meaning it's taxed less favorably. So you don't want to trigger those if it doesn't make sense. So keep an eye on that. Talk with your own tax pros. Talk with your tax advisor. Make sure this is done appropriately and that it makes sense. But for the right person, it can be a pretty cool tax planning tool within the portfolio. One last lever, and we'll take a break from all this tax conversation, but one last lever to pull is going to be donating your shares directly to charity. And, uh, for example, if you plan to make end of year donations to charity with cash or a non profit, think about donating, uh, investment shares that have highly appreciated, I mean, they've gone up a lot, uh, instead of the cash. Why? When you donate the shares themselves directly to the charity, you don't have to sell it, which means that that income doesn't end up on your tax return. Uh, the charity receives those shares, assuming they're able to do it, sells them, and as a non profit doesn't have to pay tax on that income. And then you can use the cash that you otherwise would have given to them to reinvest, reinvest back into either the same investment or to rebalance your portfolio as a whole. And you can rebalance without tax issue, right? Because you're not having to sell them. So this is a win win on both sides. You know, asset, assets are treated a little differently than cash for, for donation tax purposes. But, um, but this is something you can definitely think about doing if you are, um, We're usually giving cash at the end of the year, especially in large dollar amounts, and you have a taxable investment account. See if this makes sense. Just ask your pros, see if this makes sense. So those are the five levers you can pull. Hopefully I explained them in a way that makes sense. Hopefully you got something out of this to apply to your end of your tax planning and beyond because this is, uh, this is all a part of your regular, ongoing investment management, tax planning, cashflow planning, all of your financial planning stuff. So if you have any questions on any of this, anything we talked about, or even ideas for future episodes, uh, send me an email at evon, E V O N at optometrywealth. com. I know this can all be complicated, right? This is an example of... Now all the different parts of your finances, investment management, taxes, charitable giving, cash flow needs, all of it is a part of your combined financial planning and all of it has to be taken into account when making these decisions. So if you want to work with someone to talk through these things with, to help you navigate these decisions, reach out to me. Go to my website, optometrywealth. com. You can learn about my services and my firm and my background. Click the Get Started button on the top right and just schedule a time to chat. We can talk about whatever is on your mind financially. Um, I know I have one more onboarding spot for a new client this year in 2022, but if not this year, let's start the conversation and then get, get to work together in 2023. So, with that, really appreciate your time. I know this was a, a lot, uh, but appreciate you listening. Each and every week. Uh, I appreciate your feedback that you're providing each and every week, and we will catch you on the next episode. Take care. For more resources to help master your money, check out the Education Hub on Evon's website at optometrywealth. com. Evon Mendrin is a Certified Financial Planner and owner of Optometry Wealth Advisors, a California registered investment advisor. All opinions of Evon and his guests are their own. This show is for informational purposes only and should not be relied on for specific investment, legal, tax, or other decisions. Clients of OWA may own securities mentioned on this show.