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Taylor Schulte

Part 2: Investment Changes and Taxes

Published 3 months ago • 3 min read

Hi Reader,

Today I'm sharing Part Two of my three-part series on investing.

As shared in Part One, when you sell an investment for more than you paid for it, you can sometimes be faced with capital gains taxes.

So, how do you navigate around capital gains while also transitioning your portfolio into the right investments?

That's what I'll be sharing in today's email!

Before we dive in...did you catch this week's podcast episode?👇

Roth Conversions: How Does the "5-Year Rule" Work

I share TWO simple questions you can answer to understand this confusing rule. I also share my thoughts on the pending expiration of the Tax Cuts and Jobs Act (TCJA).

(To grab the "Roth 5-Year Rule Flowchart" referenced in the episode above, click here.)


Transitions and Taxes

When you sell an investment for more than you paid for it, there can be burdensome capital gain taxes realized in the year of the sale.

How do you manage this challenge?

How do you properly reallocate your investments without overpaying the IRS?

As a starting point, it helps to identify which trades can be placed promptly and which should be carefully managed over time.

EASY ASSIGNMENTS

Here are two conditions under which you should be able to fast-track your transitional trades:

1.) In Tax-Sheltered Accounts: Depending on the account type, you may pay ordinary income taxes when you eventually withdraw money from a tax-sheltered account.

But there are no tax consequences to the trades you make within these accounts along the way.

Because realized gains are not taxed in your tax-sheltered accounts, we can usually place trades promptly within any of them.

2.) In Taxable Accounts: In taxable brokerage accounts, you can sell targeted positions that have not grown much in value.

Those trades trades should incur few, if any, taxable gains.

If a holding has actually declined in value, you may even be able to incur a capital loss on it, which can be used to offset gains incurred elsewhere.

But, what if your plan calls for selling taxable positions that have substantially appreciated (gone up in value)?

It’s not as easy to decide whether and when to trigger these taxable gains.

Should you sell sooner rather than later? Bide your time? Skip it entirely?

Let’s look at each possibility.

OPTION #1: SELL SOONER

Nobody enjoys paying taxes. But remember…

Tax Costs Are Relative: Moving toward a low-cost, tax-efficient, well-structured portfolio should leave you better positioned to earn the highest expected returns for the costs and other risks involved.

If a careful analysis suggests the expected rewards should readily outweigh the upfront costs, it may make sense to pay those taxes anyway.

Your Mindset Matters: The sooner you sell positions that are no longer serving your needs, the sooner you can establish a better sense of control over your money.

With the improved clarity, you’re less likely to make costly, “buy high, sell low” investment mistakes in ever-moving markets.

Failing to invest consistently can cost far more than the tax hit you may need to take to acquire greater investment resolve.

You’re Buying Low and Selling High: If you sell a position for a taxable gain, you’re also locking in a profit.

Since that’s exactly what an investor ultimately wants to do, it may be worth paying reasonable taxes to periodically take some of your overweighted “winnings” off the table.

OPTION #2: BIDE YOUR TIME

Yes, there are times when paying some upfront taxes may speed your plan along.

Other times, it may make more sense to take a multiyear course toward your ideal transition.

By preparing to sell targeted positions across several years, you may be able to strike a happy medium between minimizing the impact on your annual tax rates while successfully moving toward your preferred portfolio.

OPTION #3: SKIP IT (PERFECT IS THE ENEMY OF GOOD)

Your plan also may include keeping some of your less-ideal investments indefinitely.

Even if a holding isn’t THE PERFECT position for the job, close enough may be good enough if the tax and/or trading hurdles are high enough.

Also, some of your net worth may be tied up in an employer’s retirement plan, equity incentive program, or similar account where your options are limited.

These assets still need to be considered in your overall portfolio, but they may require a different level of planning.

Bottom Line

Don’t be blindsided by taxes.

At the same time, be careful not to let an aversion to taxes blind you to the practical and emotional costs of clinging to investments that are longer than warranted.

In other words:

"Don't let the tax tail wag the investment dog!"

Fortunately, there are many ways to manage a smooth transition with your investments while being mindful of taxes.

We’ll cover some of them next week in Part 3!

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Stay wealthy,

Taylor Schulte, CFP®

Taylor Schulte

Retirement and tax planning tips...in plain English.

I'm the host of the Stay Wealthy Retirement Show and founder of Define Financial, an award-winning retirement and tax planning firm. When I’m not helping people lower their tax bill, you can find me traveling with my wife and kids, searching for the next best carne asada burrito, or trying to master Adam Scott’s golf swing.

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