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Podcast - Year End - Tax Harvesting

Year End - Tax Harvesting

Year End - Tax Harvesting

There are many things you should consider when it comes to end-of-year tax planning, but today Rich and Jag are focusing on Tax Loss Harvesting.

To understand tax loss harvesting, we will want to define terms.  Rich walks us through cost basis, capital gains (long and short term), capital losses (long and short term), carry-over losses, and the Wash Rule.

Tax loss harvesting is when you take your investment losses for the year and use them to offset your investment gains, lowering your tax burden.  Also, in years where your losses more than offset your gains, you can carry that over many years, using $3,000 of losses each year.

Rich walks us through the many benefits of tax loss harvesting, but also some of the pitfalls.  The Wash Rule comes into play here, harvesting is only for taxable accounts, and excess short-term trading can lead to headaches.


Jag: Welcome to Financial Matters with Richard Oring. I am JonJAG Gay. Rich. Good to be with you. 

Rich: Jag, it's always gonna be here. 

Jag: Today we're talking year end tax planning, many things you should consider for tax planning. But today in this podcast, we're talking about tax harvesting. Where do we start? 

Rich: Well, first off, I can't believe it's middle of October, already in the end of the year, tax planning we're already started.

This year went so quick. So I guess one of the good things is the market's down, so there's plenty of losses you can harvest this year. I mean, that's not really great, but there's plenty of opportunities for tax planning with those losses though, right? 

Jag: So it may seem on the surface like a down market could be a bad thing, but there's definitely lots of opportunities here.

Rich: You know, it's a bad thing. But let's take advantage of the tax code and see if you could save some money. 

Jag: What strategies do we start with? I'll leave it to you, Rich, point me in the right direction here. 

Rich: You know, I think, on every single podcast over the last couple ones we. I usually say, guess we gotta start with terminology.

Jag: Yeah. That's a good place to start. 

Rich: Because if I just start talking, we're not gonna understand. So let's go over the basics. And this is not just great for tax harvesting, but this is stuff you should know. First thing is cost basis. Most people already know cost basis is. What you purchased it for, but a lot of times you might have what we call drip program.

Dividend reinvestment program. Where when you have dividends or capital gains. It gets repurchased. More shares reinvested. Reinvested. So if you have a stock and you bought it for thousand dollars and it paid a hundred dollars in dividends, your new cost basis actually is $1100. 

Jag: Cause it went right back in. Okay, got it.

Rich: Well you paid tax on that a hundred dollars. So it's like they paid it and you sent it right back. And you know that's a good reminder to talk about, we're talking about taxable accounts for tax harvesting. IRAs, it doesn't count. These are your investment accounts outside your, what we call qualified accounts. Your 401K is your IRAs and so forth. 

Jag: Got it. Okay. It's point of differentiation. 

Rich: Yep. So cost basis, purchase amount, and then any dividend and capital gain reinvestment. So if you took the dividends and capital gains in cash and didn't buy additional shares, then it would just be your purchase amount.

 Now let's get into capital gains. Capital gains. So real simple capital gains in general: the difference between proceeds, that's what you sell it for, minus your cost basis. That's capital gains. It could be a loss or it could be a gain. 

Jag: So if it's bought it for a thousand dollars, if you sold it for 1100, your capital gain would be a hundred.

If you sold it for 900, your capital gain would be your capital loss, in that case would be a hundred. 

Rich: That's correct. Now that's pretty simple to understand. And we're talking about individual stock ownership, ywe're talking probably broadly right now. . But let's look at mutual funds.

Jag: A lot of stuff goes into those. 

Rich: Yep. So a mutual fund is a pooled investment of many, many, many shareholders. And some of the gains have been embedded in that mutual fund for many, many years. And you may not have participated in them, but near the end of the year, they will issue an estimated capital gains report.

It'll show the capital gains, the dividends. Interest. It's really, really important to look at those.. There are a lot of clients last year when they filed their tax return, they had a lot of big surprises when they got the capital gains reports from the mutual fund companies.

Jag: Because these were gains they may not have necessarily known about cuz they were embedded within it. Correct? 

Rich: Correct. It's very simple. You buy a stock, you hold it, you could see what you bought it for, but a mutual fund, you have no idea what those embedded gains are. The other thing is mutual funds don't pass the losses. They hold them for future years to offset gains.

Jag: So you don't get to take advantage of the losses. You only are hurt on the gains. 

Rich: That's correct. Hopefully you got to participate in those gains. Hopefully. 

Jag: Yeah. All right. Let's talk long term capital gains. 

Rich: Okay. So long term capital gains is any investment which you held for over a year. And when we're talking about long term gains and short term gains or losses, we're talking about standard investments like stocks, bonds, mutual funds, ETFs, so REITS and so forth.

But when you're dealing with like collectibles, they're gonna have a different tax rate. So we're only talking about the standard investments where you find in like a brokerage account or a Vanguard or you know, any of these institutions you're familiar with. So long term gain rates, the investment has been held for over a year.

Simple. So in our scenario before, we had a thousand dollars, we bought that three years ago, and every year it pays $25 in dividends, which we reinvest. That very last dividend will probably be considered a short=term gain or loss because that wasn't held for a year. So it's each of those purchases have their own time period of holding.

Jag: Got it. Okay. How do the tax brackets here work now? 

Rich: Long term gain rates, we always say our preferred tax rates, they're not subject to ordinary income rates. Like your income. Or, what we're gonna talk about soon, is the short term gain. They have preferred tax brackets. If you're in a very low tax bracket, it might be zero.

The average person is at 15%. And then for those who are high earners, it could be as high as 20%. The best thing to do is there's a table. You go to the IRS website, look up your tax filing, single married, head of household and your income, and they'll show you where you're gonna fall in. 

Jag: Okay, So that covers the long term capital gains. A moment ago. Rich, you alluded to short term capital gains. Those are in sale from investments held for a year or less. How does that play out? 

Rich: Sure. So like we said, you bought the investment and you sold it within one year. Okay. Ordinary. So it's dependent on your marginal tax rate at the time. Marginal tax rate is if you were to earn another dollar, that's what your tax rate would be.

So you're taking your taxable amount of social security if you're on it, or your W2 income, your Schedule C, whatever all your income sources are, that's gonna create your tax bracket,when you do all the calculation on your 1040s. And so that's what the tax rate's gonna be at. So usually for most people, that's gonna be a higher tax bracket than 15%.

Jag: So I wanna make sure I understand this cuz what you're kind of helping me piece together here is the government would like you to invest for longer term and that's why the long term capital gains have those preferred tax brackets or tax rates, but the short term capital gains, they're just gonna be taxed at the same rate as you're gonna be at for your regular.

Rich: I really don't know if the federal government really wants you to pay a lower tax bracket for gains. I'm sure they want their tax revenue. Maybe you're right. Maybe they did that incentive so people wouldn't become day traders.

Jag: Yeah. Okay. That makes sense.

Rich: I don't know. I mean, you're asking me a question I really don't know the reason, but that would be my only logical thought why. But otherwise, I'm sure the government would love for you to pay at a higher tax bracket. 

Jag: All right, so Rich, that covers the gain side of things. Let's flip the script and go over to the losses side of things. Talk to me about capital losses.

Rich: All right, so there's some basics you need to know. Again, we know it's proceeds minus cost basis, your initial purchase, dividends, capital gains interest reinvested. If there's a loss, you can take your losses to offset any realized gains. So let's go with this. Let's say you took $30,000 in gains of a particular stock, and you have another stock with $10,000 in losses.

You take the 30 minus to 10, you have $20,000 now in gains. 

Jag: So now you're only taxable on that $20,000 instead of the 30. 

Rich: Correct. So short term gains and losses offset each other, long term will offset each other. For gains and losses, if you use one completely, meaning all the losses and there's no other gains to offset, then you can use the remaining for the other category.

So let's go with long term gains and losses. Let's just say we used all our losses and we still have another $10,000 left we haven't been able to use, but there's $5,000 in short term gain. We could take $5,000 of that long term loss and offset that short term gain of $5,000. Okay. 

Jag: So in a baseball analogy here, you start off staying in the American League or the National League when it comes to short term or long term, but if you do have extra losses that don't have gains to offset them, you can go inter league there at that point.

Rich: That's correct. Now it gets even better. Okay. Let's go with more extreme loss. Let's just say at the end of the day, offsetting everything, you have a $30,000 loss. The IRS allows you to take a maximum of $3,000 loss on your return. Okay. And that saves you, cuz that saving, that $3000 is off ordinary income.

Jag: Above the line. 

Rich: It's above the line. That's correct. So that's kind of nice if you have, like I said, the 30. What you would do is you would report $3000 as a loss on your return. The other $27,000 carries over for future years. 

Jag: No matter what you have for gains in those future years. This loss, once you max it up for the year, you can stagger it over the following years as long as you're alive.

Rich: And if you don't have the gains, you can always take another $3000. So let's say next year, there's no gain. You have $27,000 carryover, you're gonna take $3000 on your return, and then you're gonna have $24,000 in carryovers for the next year. 

Jag: All right. So the next topic is something we've hit on in previous episodes, Rich, but it's relevant to our conversation here, and that is the wash rule. Talk to me about how that applies here. 

Rich: Yeah, the wash rule, it's really important to understand if you sell a stock for a loss, you cannot take the loss if you've repurchase it within 30 days. Most people think it's about the same stock, though. It's something which is really close, is identical.

So if I was to sell maybe the Vanguard S&P 500 for a loss, and then I went to go buy the iShares S&P500, that's pretty much identical. Okay? So that would not be allowed. So if you sell a stock and buy it back within the first 30 days, that loss will be disallowed. Here's another thing most people don't know.

There are special rules. It's not just for that one particular account, you own. That rule goes across all accounts. So if you think you're gonna be clever and say, I'm gonna sell for a loss in this one account, and then I'm gonna go buy in another account, not gonna work.

Jag: I see the IRS man shaking his finger at you.

Rich: Uh uh. It doesn't work that way.And then if you're really, really clever and you think you're gonna outsmart the IRS,. There's option strategies you might be thinking you're gonna utilize to buy at the current price and still take the loss. The IRS is smart enough to know that there's certain option contracts if you purchase, will disallow that loss and become a wash rule.

Jag: As a general rule of thumb, do not try to outsmart the IRS. 

Rich: That's correct.

Jag: So this is for 30 days. You can't repurchase a very similar account to the one that you sold at a loss. And then on the 31st day, that all changes. . 

Rich: That's correct. You can buy it right back. Hopefully it'll go up by then. 

Jag: Hope it goes up after you buy it back, not before.

Rich: That's correct. That's correct. . 

Jag: Okay. So that kind of talks about capital gains and losses in the wash rule, and that sets a good foundation for us here. Rich, let's transition over to tax harvesting and explain to the listeners and to me honestly, how this piece of it works. 

Rich: Sure. We pretty much almost kind of explained it just through the definitions.

You know what? Let's recap the benefits. What's tax harvesting? We're offsetting capital gains, right? If there's losses in the account, we're capturing the losses to offset gains for that year or for future gains? If we don't have any gains, we're gonna offset and we just have losses. We're reducing our ordinary income by $3,000.

They carry over unlimited for future years. As an advisor, this is what I hear, the very common comments from clients. It drives me crazy sometimes Rich. I bought this mutual fund, you know, like 10 years ago, and it's down from, its high. I agree with you. The mutual fund probably should be sold, but I wanna wait till at least it gets back to that high. 

Jag: Buy. Low sell high. 

Rich: Well, not in this case. Don't get married to your holdings. What was good 10 years ago may not be good today. Sure. Maybe that mutual fund manager you originally started with, maybe the manager left that fund retired and there's new manager. Maybe the economy isn't calling for that type of investment.

Look at this year. We're e in 2022. This was not the year of the NASDAQ so far. 

Jag: Right. Or at the same time, you might have an emotional connection to a certain company, and I'm not recommending or not recommending this company, but I'll use Peloton as an example if I can. Peloton was doing very, very well in 2020 at the beginning of the pandemic when everybody was home and looking to exercise.

 They've had some issues with their company and their stock price lately. They're not the same company in 2022 that they were in 2020. 

Rich: That's correct. And that's one of the particular stocks I do follow religiously just cause I like their story. The other thing I find people married to their stock is from an inheritance from their parents or something. You have no idea that I have clients sometimes coming to me with a half a million dollars up to a million dollars of one holding. Wow. And it makes up like 90% of their net worth. 

Jag: Literally their eggs in one basket. 

Rich: Yeah. It takes me a while when they're mostly attached to it to try to unwind it, you know, for diversification. Maybe it's not the right category to be in, the sector to be in right now. But a lot of people get emotional to holdings they inherit. 

Jag: And that makes sense. If it was a stock that your dad or your mom really liked and it's a memory you have connected with them. That makes a lot of sense. And this is something we've talked about in previous episodes, Rich, and that part of your job is to be amateur psychologist.

You have got to separate people from the emotion of their money and help them look at it objectively where you can see their money objectively in a way that your clients can't. 

Rich: I always say my job is to manage client's expectations. The hard part is when their expectations are unrealistic. Or dangerous in risk that I have to work with them to create new expectations and goals and so forth with their accounts.

Jag: Got it. Okay. 

Rich: The other thing to consider is mutual funds. Remember earlier I mentioned that you really don't know what the embedded gains are. So sometimes maybe end of October and November, December, a lot of them will issue their estimated earnings reports, like how much capital gains dividends and interest is gonna get paid out.

You would think they would just email this to you or mail it to you. A lot of times you have to take the initiative to go find it on their website. 

Jag: Okay. Good to know. 

Rich: You should look for that because if you're gonna have a year of big capital gains, distributions and you have losses in under holdings, it might be the year to offset it too, and tax harvesting would help you there.

Jag: Got it. Okay. So let's look at the other side of it. There are some cons to tax harvesting too. It'd be remiss if we didn't cover this piece. 

Rich: Yeah. I always say every strategy or investment always has pros and cons. You gotta weigh off the two, make an educated decision, so I'm glad you're bringing up the cons.

I guess the first thing is the wash rule. Especially this year, you see a lot of people who decide to start investing their own money. They don't get disciplined in holding the positions long enough. I'll give you an example. Like sometimes I will buy a stock three weeks before the earnings report.

So there might be volatility in those three weeks cuz some people are speculating it's gonna go down the earnings and some are gonna hope for surprise earnings. Like this week, right now it's October 13th, 2022. Pepsi came out with surprise earnings this week it was. That was a position we utilized in our portfolio, still in our portfolio a couple weeks ago.

So like I said, if you were looking at Pepsi from the time I bought it before the earnings release, it might have been volatile, but I bought it knowing that something's gonna happen. So the wash rule, if you're gonna be emotionally attached and buying and selling constantly, you know, looking at the losses and then saying, Oh my God, I gotta got in.

There's a better opportunity You gotta keep track on the wash rules if you're gonna be buying back that same stock, trying to time it or something. You know, a lot of people go back to their losses. Eventually they sell something, but they still believe in it. 

Jag: Back to the emotion of it. Yeah. 

Rich: Remember, this is not for your IRAs, it's gotta be for your tax law accounts. You also have to understand what assets, So again, we mentioned earlier that we're talking about investmenlike stocks, bonds, ets, mutual funds and so forth. We're not talking about currencies,precious coins, we're not talking about artwork because the IRS has a special tax rate for collectibles.

The other thing is if we're selling for a loss and we're buying something at a low, our new cost basis will be low. So you have to take that in consideration. There are strategies where you consult things for a loss and then purposely sell things which have a gain, which then would create the one with the gain, a new cost basis, you know, lower.

And the two would all set. So there are some strategies. I would talk to your accountant about that to see if that makes sense or a financial planner for sure. But the one downside I would say is whenever you're making the new purchase, it's a low cost basis, but hopefully you're investing in something you believe, which is gonna have a good return overall, and you wouldn't mind paying the capital gains. Hopefully long term, too.

Jag: Rich. I know you mentioned day trading and short term trades and you know there are apps on your phone. You can do whatever you wanna do now and buy and sell to your heart's content. There's a real inherent risk in that, right? 

Rich: Yep. Well, first off is making sure that you're not getting hit with the wash rule.

You wanna make sure you're not getting hitting with all these little ticket charges and so forth. You need to keep track of your gains and losses a lot more carefully because those gains are gonna be taxed at a higher rate. And I'm gonna say if you're excessively trading, keeping your emotions in that decision making, you may wanna step back and just slow down a little bit and be careful, especially in these times.

So, Jag, I said this in the beginning., This has been a crazy year. One of the positives things you can, I guess come out with it. Nobody wants to sell losses and lose money in a market like this. So part of what I'm saying is little being sarcastic, but take advantage of the tax harvesting. There might be a lot of it.

If you don't understand it, go online, research it, call your accountant. If you're using TurboTax, I'm sure their website has information on tax harvesting. You should understand what you're doing before doing it. So, understand it ,and take advantage of it, if it makes sense for you. 

Jag: All right. As we start to wind down the year here, you really think about utilizing professionals in your life and folks that you know, if you have a problem with your knee, you go see a knee specialist. If you have a problem with your plumbing, you go call a plumber. And in that same vein, you wanna talk to somebody who's an expert. If you wanna talk about planning for your financial future, retirement taxes, tax loss, harvesting, anything related to money, Rich is your guy.

If people wanna come find you at New Century Financial Group, Rich, how do they best reach you? 

Rich: Sure. First off, I'm a phone person. Gimme a call (609) 924-2049 extension 126. You can always go to and on that website there's a place where you can schedule a call at Zoom meeting, you can come to my office.

You can always shoot me an email. and, Jag,, you know, I love what you said about seeking professional advice. My friends will always say to me, Wow, this gotta be a really tough year for you. And what they're saying to me is because the market's down. When you do financial planning and you have a reputation out there, you actually get more business on down years from referrals or people who realize they can't do it themselves.

Jag: That actually makes sense. Okay. Yeah. 

Rich: So I get hit on two sides. I get hit with clients who they just need to hear me say, My thoughts on the market, and what I think is gonna happen and that will give them ease. Then there's other phone calls I get from clients who, it doesn't matter if you're a Trump or Biden fan or whatever, I will hear that Biden is awesome or sucks and Trump sucks or is awesome.

And I gotta deal with those calls all day because one of them is to blame for the market we are in today. 

Jag: Always, always. 

Rich: Always. And then there's the third one where people want help. You get bombarded on two different sides. 

Jag: Well, I mean, it certainly speaks to your reputation that people are coming to you when they're seeing the volatility we've experienced in the market. Always a pleasure. Rich will talk again soon. 

Rich: Thanks.