Tax-Loss Harvesting, Mortgages, Side Gigs, and More
Our main topic today is tax-loss harvesting. No surprise, when markets go down, people start wondering about tax-loss harvesting. The markets are down over 24% on the year, and it can really feel like a bad time to be an investor. We want you to remember to stay the course. Bear markets are an expected part of investing. They happen every few years. Don't deviate from your financial plan. Take this opportunity to do some tax-loss harvesting and then stay the course. We have had all kinds of questions about tax-loss harvesting and we will tackle those today as well as a few questions regarding side gigs, mortgages, 529s and UGMA accounts.
Can You Use Losses to Offset Capital Gains in Future Years?
“Hey, Jim. I'm a mid-career sports doc, living in the Southeast. First, I'd like to thank you for all you do to help doctors with their finances. You are truly one of the few trusted names in this space, and we appreciate you. With the recent downturn in the market, I have a couple of questions regarding capital losses and tax-loss harvesting. First, I understand that capital losses offset capital gains of the same calendar year and that you can carry $3,000 a year forward to offset ordinary income. Can you also use losses to offset capital gains in future years? For example, say I have $100,000 in capital losses at the end of 2022. It would take over 30 years to realize the full ordinary income benefit at $3,000 a year. Instead, could I use this loss to offset capital gains five years later? Say, I realized $50,000 of capital gains in 2027. Could I offset this with my 2022 capital losses? And if so, do these same rules apply to crypto investing as well? Going a bit further down the rabbit hole, would you consider a capital loss an asset? Could a large capital loss be considered a potential vehicle for asset protection? And finally, if one accumulates a large amount of capital loss and doesn't have a significant capital gain to offset, how is this managed with the estate planning? Thanks for your help.”
Dr. Jim Dahle:
Let's start with the basics of tax-loss harvesting. First of all, a tax loss is never a good thing. You don't want to lose money. You shouldn't look forward to tax-loss harvesting. Some people are entirely too anxious and excited to get tax losses so they can lower their taxes. Remember, the goal here is to have the most amount of money after paying taxes, not to pay the least amount of money in taxes. What tax-loss harvesting is, is making lemonade out of lemons. It's letting Uncle Sam share in your pain. The idea behind it is you are selling an asset that has a loss in a taxable account. You don't do this in 401(k)s. You don't do this in IRAs. You don't do this in 529s or HSAs. Only in your taxable account. You sell something, and when you do that, you are realizing a loss. You've lost money.
When you do that, the IRS lets you use $3,000 per year of that loss against your ordinary income, and you can use an unlimited amount of that loss against your capital gains. That's basically what a tax loss is. People get excited because they can lower their taxes with it. Then they can start getting creative with it thinking about how to grab that tax loss without selling low or without buying high and selling low, which is what you don't want to do as an investor. So, they came up with tax-loss harvesting, where you get the loss, but you're not selling low. The way you do that is you exchange from one investment to another. You're selling something with a loss and you're buying something very similar to it but, in the words of the IRS, not substantially identical. Then, you get to claim a loss and you haven't changed your asset allocation. You're basically invested the same way you were before, but now you have the loss you can use on your taxes. That's what tax-loss harvesting is and why you might want to do it.
Let me go through the specific questions here that this listener had. One, there was a little bit of confusion about carrying it forward. He said carrying $3,000 forward. That's not the way it works. You carry them all forward. If you don't use them that year, you carry them forward indefinitely. That's not an issue. What the $3,000 is, is that's how much you can use against your ordinary income each year.
Then, he asked lots of really interesting questions. One was about crypto. There's a loophole here for crypto. Normally when you are tax-loss harvesting stocks or mutual funds or bonds or whatever, you cannot buy back what you just sold for 30 days. That is not the case with crypto. If you do, that's called a wash sale, and your loss is disallowed. You basically just have your basis carried over to whatever the new thing you bought was. But you don't get to use the loss. In general, you try to avoid that. That counts for a period 30 days after, as well as 30 days before. You can't buy the new thing and then sell the old thing the next day. It's got to be 30 days apart between those two events.
That doesn't mean you can't sell something you just bought. You just have to sell all of it. For example, if you bought a bunch of Total Stock Market shares last week, and now you have a loss, you don't have to wait 30 days as long as you're selling them all. If you sell all your Total Stock Market and exchange it for an S&P 500 Index fund or whatever, those two funds have a correlation of 0.99. They're going to perform essentially the same, but you book that loss, you are fine. But what you can't do is own a whole bunch of Total Stock Market and only sell part of it and then buy some and then sell some more. You have to be a little bit careful with the wash sale rule. That one burns a lot of people.
The other thing that burns a lot of people is what's called the qualified dividend rule. A lot of your investments pay out dividends and they're qualified dividends, meaning they're qualified with the IRS for a lower tax rate. One of the rules in order for those to be qualified is that you have to own the investment for at least 60 days around the time of the dividend. If the dividend is paid out on June 25 and you bought it on May 30 and you sold it on July 4, that's not 60 days. That dividend becomes unqualified and you pay taxes on it at your ordinary income tax rates, not the lower qualified dividend tax rates.
This burns people when they're frenetically tax-loss harvesting, when they're tax-loss harvesting every two days all month. Then, they realize that they've given up more tax benefits by not getting the qualified dividend rates than they gain from the tax losses from tax-loss harvesting. Quite frankly, you probably ought to sit on your thumbs a little more often and only tax-loss harvest every two or three months, even in a dropping market. Don't get too carried away with it, or you may end up doing more harm than good.
He asked a couple of other interesting questions there. One question that I don't think I've had anybody ask me before was whether there's some sort of asset protection benefit from having a whole bunch of tax losses. I can't think of one. This isn't like having a big mortgage on a property where you've kind of stripped the equity out of the property. It's just a loss sitting there waiting for you to be able to use. I wouldn't think of it as some sort of an asset that you could use for asset protection. It might help lower your future taxes. That's not going to protect you from your creditors. Also, these all go away when you die. You don't pass these on to your heirs. The good news is your heirs get a step up in basis when you die, but they don't get to carry forward your tax losses. So, as you can tell, the first $3,000 per year are really valuable. Some amount above and beyond that is pretty valuable. And at a certain point, it really doesn't help you at all. There is a limit to how useful tax-loss harvesting can be.
I understand you're going to be doing your first tax-loss harvesting here coming up, Disha.
Dr. Disha Spath:
Well, I'm trying to decide, honestly. I've been bingeing on all your articles and Physician on Fire's articles about this because you can't do it unless you have a brokerage account. Josh and I just recently started investing in the brokerage outside of the retirement accounts. Now we can actually capture some of these losses, but my whole setup's been automation. It seems that I would have to change a few things. I'm really excited that you are going over all of the details because I feel like a lot of us do this where we just invest a set amount every month and it does it automatically, and I reinvest the dividends. I think I would need to look at all of that and make sure that I sell the ones that I just bought automatically, turn off the automation, and then also turn off the reinvestment of dividends and try to do that manually.
Dr. Jim Dahle:
Yes, this is a big problem people have. I get this question by email all the time. Automatic investing and tax-loss harvesting do not play well together. It doesn't work well. It's great to reinvest your dividends. It does create a lot of tax lots to keep track of when you do that. I'm not really a fan of doing it in your taxable account. And it's great to automatically invest every week or every time you get paid or whatever. You get that money in the market and it's working right away. You end up getting the benefits of this periodic investing, and you end up doing really well in the long run. It's really a great strategy. It just doesn't play well with tax-loss harvesting. What I end up doing is I take all the money I made that month, whatever it is, whether it's from dividends or whether it's from real estate rents, whether it's from my clinical practice, or whether it's from WCI. I look at it once a month, and I invest it manually. I don't actually do any sort of automated investing.
Early in the year, it's going into 401(k)s and Backdoor Roths and HSAs and the kids' UTMAs and 529s and that sort of stuff. Later in the year, it tends to all go into taxable. But I've essentially given up the benefits of automating everything in order to have a little more control over my taxes. Whether that's right or wrong, it's hard to say. There are people out there that just don't feel like tax-loss harvesting is worth the effort. I mean, if you think about it, if you're only getting the $3,000 a year. That's only about $1,000 off your taxes, and for most docs, it's not a huge amount.
The truth is for lots of people, if they end up selling those shares eventually, they're only delaying the payment of the taxes on their long-term gains. Which, there's a benefit there, but it's not a huge benefit unless you're somehow flushing the capital gains out of your portfolio, like I do with charitable giving. Then you're just delaying when you pay those taxes. There's a pretty good argument to be made not to tax-loss harvest at all. But I think it's worthwhile. I combine it with charitable giving and it becomes very powerful for us.
Dr. Disha Spath:
That's awesome. I think a little bit also has to go with your self-awareness of how well you're going to do if you do turn off the automation, especially in this kind of a down market where if the investment becomes optional every month, then are you going to stop investing? You really need to know your behavior.
Dr. Jim Dahle:
Yes. It’s the classic behavior vs. math thing. I mean, mathematically, you can make a pretty good case for tax-loss harvesting. Behaviorally, automating things is really powerful. It helps a lot of people to become millionaires, just putting things on automatic autopilot and going about their lives. I mean, how much time do you want to spend on your finances? You have to ask yourself that when you start looking at things like tax-loss harvesting. Like all the real estate investing we talk about here at the White Coat Investor. It's optional. You don't have to do it. You can become a financially independent multimillionaire without investing in real estate at all. Tax-loss harvesting is kind of the same way. It's optional. You don't have to do it.
More information here:
Physician on Fire's Tax-Loss Harvesting Tips
Tax-Loss Harvesting and Wash Sales
“How about a deep dive into tax-loss harvesting and wash sales? Not just the basic rules, but the intricacies of what could trigger a wash and how to avoid it and case examples of that. The second thing that could be discussed is whether municipal bond funds or ETFs can be tax-loss harvested. A third thing could be discussed is the tax treatment for home improvements or special assessments by condominium and how they should be accounted for.”
Dr. Jim Dahle:
There are more questions to come from this reader's email but let's pause here and take the second one first. This one's easy, right? You can tax-loss harvest bonds. Up until this year, I'd never tax-loss harvested bond funds or ETFs. This year, I've already done it twice. I probably need to do it again. Typically, bonds don't lose as much money as they've lost this year. It's kind of presented a unique opportunity. You do it exactly like stocks. You find a similar bond fund or ETF, and you exchange for it. You sell one, you buy the other one, no big deal and you get the tax loss. No reason you can't do it with bonds. It's typically not done, but I'm doing it. So, no reason you can't.
Let's do that condominium question too. That one is pretty easy actually. Tax treatment for home improvements, special assessments by condominium, etc, those all add to your basis. They don't give you any sort of deduction this year. What they do is they can help you potentially when you go to sell the property. A lot of times, you're not paying capital gains when you sell a property because you're within the exemption amount. It's $250,000 single, $500,000 married. If you've gained less than that on your home, you don't pay capital gains when you sell your residence. But if you were above that amount, this amount you added with home improvements, with special assessments by condominium, or like the big renovation we did a couple of years ago on our home, you have to pay the gains. I kept the receipts from our renovation because I want to be able to add that to the basis of what I paid for the home should I ever sell it, and I don't want to pay taxes on that amount. So, that's all you get for home improvements. On an investment property where you're more likely to be paying some gains, it helps more significantly than with your residence. It's worth keeping track of them. Just don't expect a lot of benefit for it most of the time.
Dr. Disha Spath:
What about the interest from it? Like if someone took out a HELOC and the interest they were paying on that? Is that deductible for a home improvement project?
Dr. Jim Dahle:
It depends. For the home improvement project, it is. I think up to $100,000 is deductible. If you take it out and use it to buy a wake boat or to go heli-skiing, it's definitely not deductible. Now, money is fungible. I don't know how closely they're really looking at that, but those are the rules. The interest on the first $100,000 of the loan is deductible.
Let's talk about some case examples.
Mostly it's people getting burned by wash sales, because they're doing them too fast. If you just slow down, all those questions go away. You don't have to get burned by the 60-day rule. You don't have to get burned by the 30-day wash sale rule. Just chill. You're going to have enough losses in your life if you have a taxable account of any significant size to always get your $3,000 a year and to have significant other losses for whatever you might need them for. I don't feel like you need to get all these losses in one year. I totaled up the number of tax losses we've got saved up right now. We're at three quarters of a million dollars. I mean, how many years is that? Two hundred years at $3,000 a year. I would've stopped accumulating them a long time ago if I didn't think there was a possibility of selling The White Coat Investor at some point down the road. That's the only reason I'm still picking these things up. Otherwise, I would just let it go.
You only need so many. So chill, you're going to get the losses. Don't worry about that. They will come and you don't have to go hire a robo-advisor to get every single dollar of anything that ever drops. If you're a high-income professional and you're building this taxable account, you're eventually going to have enough money in there that any reasonable downturn that's going to happen every two or three years, you're going to grab some significant losses with.
Dr. Disha Spath:
Jim, I'm sorry to interrupt you. I wanted to ask a question. You were talking brokerage when you're talking tax-loss harvesting, but wash sales also include the transactions you're making in other accounts, right? Some other accounts. Which other accounts are those exactly?
Dr. Jim Dahle:
Well, the IRS is very specific about it. It counts in IRAs, but it does not count in anything else. You can't sell something in your taxable account and buy it the same day in your IRA. That's technically a wash sale. Now, is the IRS going to catch it? Almost surely not, because your taxable account and your IRA are probably at different places. If the broker doesn't report it as a wash sale, nobody else is going to catch it as a wash sale, but that's the law.
Dr. Disha Spath:
OK.
Dr. Jim Dahle:
Some people have speculated, that maybe that applies to 401(k)s too, but there's really no evidence that it does. The IRS has not specified that. There's nothing really keeping you from selling something in taxable, buying it in your 401(k). But honestly, how hard is it to find a tax-loss harvesting partner with a correlation of at least 0.99 in your taxable account? It's not that hard. There are dozens. If you're holding a Total International Stock Market Fund or you're holding a muni bond fund or you're holding a Total Stock Market Fund, it's not like it's hard to find something to switch into. You don't have to play these games with your other accounts.
But your HSA doesn't count, your kids' UTMAs don't count, 529s don't count, 401(k)s, 403(b)s, 457(b)s, whatever they're doing in your cash balance plan, that doesn't count against your tax-loss harvesting. But you can't do it in your IRAs. You can't sell one in your IRA and buy it in your taxable account, etc. That could cause a wash sale.
What other questions did he have in this lengthy email?
“Regarding tax-loss harvesting, I think it's important to get into the nitty-gritty. For instance, what counts as like accounts.”
We just talked about that.
“Obviously, if I have something in my tax advantage account, I can't cover for my taxable account, but what about UTMA exposures?”
As we just discussed that doesn't matter. It's only IRAs.
“Also, what if you sell fully out of a position vs. just a single lot?”
Dr. Jim Dahle:
If your taxable account is at Vanguard, or you can do this at Fidelity or Schwab or wherever you are. You go in there and you click on their cost basis tab and it'll give you an option: unrealized gains, realized gains, and something else. Just click on the unrealized gains. Then, there's a little button there underneath each holding that you can click on. It shows you all your tax lots. Disha, you'll notice this when you go in there because you've been reinvesting your dividends, you're going to have some big tax lots, and you're going to have some little tiny tax lots that are maybe just a few dollars, whatever the size of that dividend was. But all your tax lots will be listed there. It will show you what the gain or loss is on that lot. Whether it's short term, whether it's long term, whether it's a gain, whether it's a loss and you can then choose which of those lots you want to sell. You click the ones that have losses and you sell those. You don't have to sell everything. You can just sell those lots and then buy something similar to it.
In my case, I tend to go from a Vanguard Total Stock Market ETF to an iShares Total Stock Market ETF. They're different holdings, they have different CUSIP numbers, different numbers of stocks in them even though they're very highly correlated. I don't expect any different investment performance out of them, but they're not substantially identical. That's what I would do with those lots. Now, when you get burned on that is when you're trying to do this frenetic tax-loss harvesting, and you're doing all these different transactions inside the same month. You have to be careful because if you've just bought something that can cause a wash sale, unless you also sell what you just bought.
Let's say you're investing automatically, like you do, Disha. Let's say you're putting $2,000 a month into this Total Stock Market fund. On the first of the month, you bought $2,000 of it. At mid-month you're like, “Wow, I've got a loss on four lots, my last four months’ worth of purchases of this holding. I'd like to tax-loss harvest it.” That's fine. You go back and you sell those last four lots. You just have to make sure that one of those lots is the one you just bought within the last 30 days. As long as you're selling that, the loss counts, there's no wash sale. You can turn around then and buy the iShares version of it or whatever. And you're fine. You've booked the loss. You're not going to have a wash sale.
Dr. Disha Spath:
Got it. I actually logged in today and I was really confused initially, because I was only seeing average prices. I just saw VTSAX average price, and this was your total loss. But I wasn't seeing the tax lots. There was just a cost basis method setting in Vanguard where instead of using the average cost, you have to switch it to special identification, and then it shows you the lots.
Dr. Jim Dahle:
Yeah. That's a good point actually. It's really important. Specific identification is what you want. Every time you buy a new holding in your taxable account, choose the way they're going to keep track of the cost basis for you and what you want is specific identification. When you go to sell those lots, whether you are tax-loss harvesting or whether you're selling them in retirement to pay for living expenses, you want to be able to pick which lots you sell. Because in retirement, you want to pick the ones that are going to cost you the least amount in taxes, ones with the highest cost basis. Obviously, when you are tax-loss harvesting, those are the ones you typically sell as well.
The questioner gives an example in this email.
“What if I hold VWO? Then I sell all shares of VWO and switch into IEMG. IEMG then goes down significantly over the course of 20 days or so under the 31-day requirement. Then I sell out of all my position of IEMG at that 20-day mark.”
That's great. You get the loss from that as well.
“But I don't buy into VWO until 30 days have elapsed since I was in VWO.”
I might wait 31 days just to be sure, but yes, that works.
“Since I sold out of the full IEMG position, can I take that as a loss too?”
Yes.
“Also, if you have a taxable gain in a real estate sale, can an unlimited amount of carry forward investment taxable account be used against that?”
Yes. If you have a capital gain from real estate sales, you can use losses from your taxable investing account. You can book all these losses on mutual funds and you can use them on real estate capital gains. You absolutely can do that.
More information here:
The Case Against Tax-Loss Harvesting
Can You Hold Losses Until You Are in a Higher Tax Bracket?
“I am a second-year medical resident about to book $9,000 in tax losses for harvesting. I'm wondering if I can hold these losses for several years until I'm in a higher tax bracket, start working as an attending, or if I have to use the $3,000 annually plus capital gains tax offsetting.”
Dr. Jim Dahle:
I just laugh at this question. First of all, you're doing awesome. If you have enough money in a taxable account as a resident to lose $9,000, you're awesome. I didn't even have a taxable account for most of my career. I'm pretty amazed that a resident even has a tax account. What that tells me is you're maxing out your 403(b) and your Roth IRA. If you have a spouse, their accounts, and you're still investing enough that you can lose. Congratulations. You're doing awesome. But the other funny part about this question is they're worried they're never going to have another loss. “Oh, I have to save this loss. I'm never going to get another one. The stock market is never going down again.” Use the loss. Just use it.
Dr. Disha Spath:
I think we talked about this earlier, Jim. I don't think there's any way to fill out that form to not use that loss. If it's there, you have to account for it.
Dr. Jim Dahle:
Correct. You can't carry it forward. You're right. The same form you use to use the loss is the form you use to carry forward the loss. It's your Schedule D on your taxes. So, it's not like you can save them in your pocket and use them later. You wouldn't want to anyway. Just use them.
What's his next question?
“In the same context, I am in the 0% long-term capital gains bracket but have some annually accruing realized capital gains for my mutual funds. Do the tax losses get used up, even though I'm not paying taxes on, let's say, $1,000 in long-term capital gains?”
Dr. Jim Dahle:
That's a good question. Do they get used up? Yeah, I think they do. I'm sorry you're in the 0% tax bracket. It must be terrible. But yes, if you've got capital gains, I think they're wiping out capital losses. Even if you're in the 0% bracket. I would have to work through the taxes to make sure on that. I'm not 100% sure, but I think that's the way it works is that losses offset gains on Schedule D and then after that, they figure out which bracket you're actually in. I think you are using them up, even if you're in the 0% bracket, but I'm not 100% sure.
Tax-Loss Harvesting and Capital Gains Taxes
“Could you theoretically tax-loss harvest enough to negate all the capital gains tax you have when you start retirement or whenever you start selling assets?”
Dr. Jim Dahle:
Yes, you could. It's all about how many gains you have later. Hopefully, you don't have enough losses to negate all your capital gains. Because that means you're coming out behind. Now, the exception, of course, is if you're doing what I'm doing, where you take your really appreciated tax loss and you use those to give to charity, then you could accumulate losses far in excess of your gains. But for most people, if you have more losses than you have total gains in that account, you've lost money. You are not investing well. If that happens over decades, you've really kind of botched your whole investing strategy. That's not a good thing, but it's possible.
In reality, what happens is you've booked these losses as you go throughout your career. All your stuff has gained and gained and gained throughout your career and you get to retirement. Then you realize your dividends and Social Security and pensions aren't going to cover what you want to spend in a month so you sell some assets. Then you decide which assets you're going to sell. You sell the ones with the highest basis and maybe 90% of the value of what you're about to sell is basis. You don't pay taxes on basis. You only pay taxes on gains. You might pull out $50,000 of that account and only have to pay taxes on $5,000 of it. Now, if you're carrying around a quarter-million dollars in tax losses, that comes out tax-free. It's just like a Roth IRA withdrawal. For many years, you probably don't have to pay. If you've been diligently tax-loss harvesting, you probably don't have to pay any capital gains on that money for quite a while. But eventually, you're going to run out of those high-basis shares. Eventually, you're probably going to run out of those tax losses and have to pay some dividend taxes. But that's not such a bad thing.
“How do you keep track of losses over the years? Do you save them on Excel?”
Dr. Jim Dahle:
I don't. I save them on my Schedule D tax form. Every year, your Schedule D totals it up and at the bottom, it has your total amount of tax losses you're carrying forward. I think last year I was carrying forward $365,000 in tax losses. Obviously, this year has not been good to us. I have a whole bunch more tax losses. Next year, when I get to the bottom of the form, it'll say something like $800,000 in tax losses, and I'll use $3,000 against my ordinary income. If I have any gains for whatever reason this year, then I may use some of those up. But everything else will be carried forward. That's just the way it works. It just goes forward from one Schedule D to the next. No reason to open an Excel file, unless you are worried you're going to lose your tax forms, I guess. But since you've got to keep them for seven years, it doesn't seem that hard to keep last year's.
More information here:
Capital Gains Tax: An Unavoidable Reality
Physician Loan or Conventional Loan
“Hi, thank you for all the wonderful resources. I'm a recently graduated MD/Ph.D. student that matched into a dermatology program in the East Coast. My wife and I are looking to buy a house in the $400,000-$500,000 range for my residency training and potentially beyond. With my wife’s resident salary, we'll make a combined income of $150,000-$160,000, and we have saved $100,000 for a down payment. All the credit goes to her. We have excellent credit scores and less than 30% debt-to-income ratio given that my program provided complete tuition remission. Would you advise us to take a physician loan so that we have more fluid money or do a conventional loan with 20% down but that means a little bit more difficult leaving? Thanks again.”
Dr. Jim Dahle:
There's no right answer to this question. This is a classic question. The first thing I ask is, “Do you really want to buy a house at all?” You're going into residency. You didn't mention how long your residency is, but on average, it takes about five years to make buying the right decision. Lots of residencies are only three or four years long. For lots of people, no matter how much money they have saved up, no matter how much their spouse makes, the right answer is to rent. That's question No. 1. Should you be buying in the first place? I'm assuming that you have already thought through this and for whatever reason have decided you're buying, whether you just don't care or you couldn't find a decent place to rent or you're going to be there for many years or whatever reason you're going to buy anyway. So, hopefully you have considered that.
Dr. Disha Spath:
Can I chime in?
Dr. Jim Dahle:
Absolutely.
Dr. Disha Spath:
I would add, that a good reason to buy a residency house would be if you are actually looking into real estate investing and you want to buy a house that you want to later keep as a real estate investment and rent it out. That's one way I've seen a lot of physicians do well in buying a resident house. You have to actually buy the house that's going to rent out and make sense in the numbers and cash flow. That's the caveat.
Dr. Jim Dahle:
Yeah, exactly. I'm going to push back on that for two reasons. The first one is lots of people leave that area. Now you're a long-distance landlord. Those of us who went through residency in the late 2000s and then came out and couldn't sell houses because nothing was selling and were forced to keep it as a rental, often at a loss, and while you lived in some other city didn't love it. People were not very happy about that. That did not end well for them. So, you've got to keep in mind, are you willing to be a long-distance landlord if you do that?
Dr. Disha Spath:
Right. And if that's in your plan.
Dr. Jim Dahle:
The other point you made is that people don't buy the houses they live in the same way they buy their rental properties. When you go to buy this house you want to live in, you're thinking about the school district and the colors on the walls and is the backyard perfect for my dog? When you buy a rental property, it's about the numbers. What's the cap rate? What's my net operating income going to be? It's a little bit different calculus. If you're willing to buy the place you live in for three or four or five years by the numbers, I think that can work out. Lots of people do get their start real estate investing that way. But you have to do it as a real estate investment from the beginning.
Enough of that preamble. Let's talk about conventional loan vs. physician loan. A physician loan is 0%, 5%, 10% down instead of 20% down. You get to avoid private mortgage insurance either way. It's just a question of, “Do you have a better use for that down payment or not?” My recommendation when you buy a home is that you keep your mortgage to less than two times your gross income. The only way this couple is going to do that is by using that down payment. If they want a $400,000 or $500,000 house and they're only making $160,000, they have to put some money down in order to keep that under 2X. So, that's probably what I'd do. I'd put the money down in that case.
But if you feel like you just have these awesome investments or you have 8% student loans you want to put the money on or you have some much better use for your money, then I think you can do that. It's not the end of the world to use a physician mortgage loan. They'll certainly give you one. There's no doubt about that. You're going to qualify for one. It's just a question of what you want to use your money for. I think I'd put it down on the house if I was set on buying this particular house. How about you, Disha? What would you do? Would you invest it or would you put it down given their numbers?
Dr. Disha Spath:
It totally depends. I think the mortgage amount would be too much without putting it down at their income level right now, as residents. Of course, when they're attendings, it'll be a totally different story. But they're looking to take on a decent size mortgage to do that. If I was going to buy a house as a real estate investment, the less you put down, the better you do number-wise from a return perspective. If you have a higher mortgage, obviously, you're going to have lower cash flow, but you get a higher rate of return of your money if you don't put anything down.
Dr. Jim Dahle:
Assuming the house appreciates.
Dr. Disha Spath:
True, assuming it all works out in your favor. And it's a good investment.
Dr. Jim Dahle:
Right. Leverage works.
Dr. Disha Spath:
We have to realize this is leverage. You take risk. If you don't put down the cash, the more mortgage you take on, the more risk you're taking on. And it depends on how much risk you're willing to take on, on your primary home. And it depends on how much risk you're willing to take on overall and what stage of life you're in. There's a lot that depends on the situation for this one.
More information here:
Are Physician Mortgage Loans a Good Idea?
Getting Your Finances in Line for Your Side Gig
Dr. Jim Dahle:
Next, we have a question that came in from a reader with a random podcast idea.
“What about something on getting your finances together when starting your side gig? There's lots of talk on the podcast about side gigs, expert witness, etc. And I feel like a good portion of your listeners are primary W2 earners but have some small amount of 1099 income either for themselves or a spouse. Granted, each person's financial situation is different, but I think there's also a lot of overlap. Practical example, I think of my wife, a urologist who made about $20,000 last year in 1099 income from serving as a consultant for a medical device and pharmacological drug. Simple things like tracking expenses, what can be deducted, organizing paperwork, per diems when traveling, contract review for the 1099, managing risk exposure, etc. For example, looking back, I wish she had a separate credit card for all of her 1099-related expenses and used a smartphone app. In summary, you landed a 1099 side hustle, now what?”
How would you advise somebody, Disha? We both started businesses. What are the basics of starting a business? That's what they're asking.
Dr. Disha Spath:
I think that makes a lot of sense, what he mentioned with a separate credit card. That's what I did when I started my LLC. I got the EIN and then I used that to open a separate checking account and credit card. That way, I could keep those expenses completely separate from my personal expenses for accounting purposes. Then I use a web-based platform to do the accounting for me in those two accounts. That does help a lot in the year-end or quarterly tax payments that we have to make. What about you, Jim?
Dr. Jim Dahle:
Yeah, not that complicated. You get an EIN, that's free. It takes 30 seconds online. Just Google “Get EIN” and it’ll take you to the IRS website and give you one. I agree. Separate bank account, separate credit cards, it’s pretty helpful. I tended to just keep books for really simple business in Excel. I found that pretty easy, but as it gets more complicated, most people transition to something like QuickBooks. That's what we use for WCI now. You have to keep track of your expenses. Any business expense can be deducted. Should you get a contract review? Yeah, you probably should get a contract review if you've got some sort of a complicated contract for that 1099 thing, just like you would any W2 job.
Managing risk and exposure: If there's some significant business liability, it's worth forming an LLC. If you're just moonlighting, the LLC isn't going to protect you from your main risk, which is malpractice. So, I don't see any point in starting that unless you're going to try to file as an S Corp or something and trying to save Medicare taxes. But that's kind of the basics of starting a business. Make sure you pay your quarterly estimated taxes. That's probably the most complicated thing for people. If you're only making $20,000 and you've got a physician kind of income on the side, you're probably withholding enough from the W2 job that you don't have to make additional payments. But if you make $200,000 in your side gig, you'd better be planning to make significant quarterly estimated payments every quarter to stay up with the IRS.
More information here:
Estimated Taxes and the Safe Harbor Rule
529 Withdrawls
“Hi, Dr. Dahle. This is Murray from Los Angeles. Thank you for all that you do. I have an observation and a question regarding 529s. This year was my first time making withdrawals. And I was surprised that in filing the 1099-Q, I was expecting to have to prove somewhere that the number in box one, the total distributions, would have to be followed up somewhere with your documentation or proof on how much of that is qualified. I was surprised when this wasn't the case, and when I looked into it in the WCI forums, the recommendation was to just tuck your 1099-Q form and any relevant documentation in your tax folder. So, in reality, it seems you only have to show your distributions are qualified in the event that you are audited, I suppose.
My question regards timing the withdrawals. I was thinking that with the market being what it is currently, and right now it's early May, I might pay the first set of tuitions out of cash stores to give my 529 some time to recover. What is the latest that I can withdraw the money? The same calendar or tax year in which I paid the bill or the same fiscal or academic year? I can't seem to find this clearly documented anywhere. I would obviously prefer the latter, and that gives a little more time for things to potentially recover. Thank you.”
Dr. Disha Spath:
I believe for 529 withdrawals you have until the end of the calendar year. Right, Jim?
Dr. Jim Dahle:
Yep. That's absolutely right. We're withdrawing for the first time this year in 2022. Whitney is starting college. And she came to me to get some money out of her 529 to pay tuition. Because her tuition was not due for a few months, we decided to wait to take the money out in hopes the market might recover a little bit before we took it out. But of course, the market has continued down. We should have taken it all out a couple of months ago and paid tuition months early. But that's fine. Our whole plan is to keep it invested aggressively and take advantage of that over the long run. We're only pulling out a tiny percentage of what's in there anyway to pay tuition right now. But yeah, that's the way it works. You have to the end of the year if you want to pay in cash and wait until December 27 to pull all the money out. Nothing to keep you from doing that.
UGMA Accounts
“Hello, Dr. Dahle. First off, I wanted to say thank you for this community. My husband and I met when we were both just out of residency, and I found out on our first date that he also read your blog. I think that helped him get a second date and the rest is history. Anyway, my question for you. I was the very fortunate minor in a UGMA account that my grandparents contributed to when I was a young child. The money was invested by my father in a few Vanguard actively managed value funds. I sold a chunk of the funds to pay for college and medical school, but I also received some scholarships and lived very frugally while I was in school. So even after those expenses, I still had money left over.
The first world problem that I am facing now is the tax inefficiency of these funds. The expense ratios are 10 times higher as compared to the ratios of the low-cost funds and ETFs I'm using now. Also, as value funds, they give off a decent amount of dividends and capital gains of about $30,000-$40,000 a year, which I pay taxes on. But I don't take the money out. So, it's a little painful to pay taxes on money I don't really appreciate as income. I'm also young in my career and I don't really need passive income at this time. If I were to sell the funds, I'd have to pay capital gains on about $140,000, which is painful. So, I'm wondering what the best thing to do is with these less-than-ideal funds. Thank you.”
Dr. Jim Dahle:
Congratulations to you, Amy. This is indeed a first-world problem. If you have enough money left to you that it now kicks out $30,000 or $40,000 a year in dividends, this is a substantial account we're talking about. This is hundreds of thousands of dollars. So, congratulations to you. That's wonderful. It's a great problem to have. I do empathize with your tax concerns. The only thing worse, of course, than paying taxes is not having to pay taxes because you don't have the income. This is not all bad. I wouldn't even call it an UGMA account anymore. I mean, this is just your taxable account at this point. Once you hit age 18 or 21 or 25, depending on the state, it just becomes your taxable account.
You have legacy holdings is what we call this. Something that you wouldn't buy today but that you don't want to sell because the tax consequences are so painful. The way you deal with these things, if they have a loss, is to just sell it. It's just like tax-loss harvesting. If there's not much of a gain, again, you can sell it. No big deal. If you have a bunch of tax losses saved up from something else, you can use those to offset your gains and you can get into the portfolio you'd really rather hold. But if you're in the situation that you're in, where this is a large amount of money with a large amount of gains that you don't want to pay taxes on, then what you end up doing most of the time is building your portfolio around it. And that's fine. These are Vanguard funds; they are value funds. Yes, the expense ratio might be 10 times what an index fund is. But they're probably still only 0.3. These are well below-average expense ratios. This is not a terrible thing to hold in your portfolio long-term.
Jack Bogle himself had lots of these sorts of holdings in his account that he wasn't about to sell because of the tax consequences. Don't beat yourself up about it in any way shape or form. Just take advantage of it. It's great to have the income, even if you're paying taxes on it as you go along. Maybe you don't want to reinvest those dividends. Maybe you have them paid to you, and that way you'll have the money to pay the taxes on them. Then if there's extra, you can reinvest that or do whatever you want with it.
Another thing I would consider doing—because we give a lot of money to charity—is if you also give a lot of money to charity, these are the shares you should use to give to charity first. They're something you don't want. They're highly appreciated. You don't want to pay capital gains on them. If you either give them directly to a charity or give them to a charity via a donor-advised fund, you basically wipe your slate clean of these capital gains. Instead of giving cash, you're giving these appreciated shares, and then you can buy what you want with the cash. That's also a great way to do it. If you're not a charitable person, that might not work out very well. But if you are, this is a great way to get rid of legacy holdings.
Dr. Disha Spath:
Good point. Thank you, Jim. I appreciate you really telling us about donor-advised funds and reminding us that that is also an option. And thank you for asking this question, Amy, because this is something that's very relevant to a lot of white coat investors.
Sponsor
Clarification from Podcast 264
Somebody wrote in, “Like any savings bond, if you use EE bonds to pay for higher education, you don't have to pay taxes on those earnings. That's the same between EE bonds and I bonds. However, what you may or may not realize is for a lot of our listeners, high earners, you don't get that. There's a phase-out on savings bonds for education.”
If your income is more than a certain point, you don't get that benefit. That limit right now starts at $100,800. For joint filers, it phases out between $128,000-$158,000. For everybody else, if you're single, it starts phasing out between $86,000-$101,000. So, for lots of our readers, that's not a benefit for you. We probably should have mentioned that. At any rate, now you know.
Course Sale
WCI is having a huge course sale. All courses are 20% off from June 28-July 11. This is the biggest sale we offer so if you have been wanting to try one of our online courses, do not wait! Just go to whitecoatinvestor.teachable.com and use coupon code BIRTHDAY2022
Quote of the Day
Henry David Thoreau said,
“The man is the richest whose pleasures are the cheapest.”
Milestones to Millionaire
#73 — Radiologist Pays Off Student Loans
Radiologist pays off $75K. That may not seem like a lot. But he shares some great advice from his journey to being debt-free, recognizing the sacrifice of his spouse in frugality and his parents’ sacrifice for funding a 529 so he could do medical school with only $75K in debt. This lower debt freed him up to have no limitations on the job he could accept post-training.
Sponsor: PKA Insurance Group
Full Transcript
Intro:
This is the White Coat Investor podcast, where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.
Dr. Jim Dahle:
This is White Coat Investor podcast number 270 – Tax-loss harvesting, mortgages, side gigs, 529s, and UGMA accounts.
Dr. Jim Dahle:
I'm here with my co-host, Disha Spath, and my name is Jim Dahle, the founder of the White Coat Investor. Welcome to the podcast, Disha.
Dr. Disha Spath:
Thank you for having me.
Dr. Jim Dahle:
Let's tell them about our sponsor. Now is a great time to start thinking about reviewing your last tax plan or starting a new one to make sure you're taking advantage of all the available strategies. Waiting too long into the year can result in lost opportunities to keep more of your hard-earned money in your pocket.
Dr. Jim Dahle:
If you haven't heard about Cerebral Tax Advisors, physicians all over the country work with them to lower their personal and business taxes through court-tested and IRS-approved tax strategies.
Dr. Jim Dahle:
Medical professionals rely on Cerebral Tax Advisors for proactive tax planning strategies for doctors helping them lower their effective tax rate and increase their wealth. If you'd like to find out more, schedule a pre-consultation, visit their website at www.cerebraltaxadvisors.com.
Dr. Jim Dahle:
All right. A great opportunity there. If you haven't met to Alexis Gallati you can talk with her at Cerebral, great person and lots of awesome stuff they're doing there. Well, it's good to have you back on here. I haven't talked to you for a few weeks. I guess it's summertime and we've been off doing fun stuff or working or something.
Dr. Disha Spath:
I know, right? Thank God. I'm so happy about this weather. I need the vitamin D.
Dr. Jim Dahle:
Yeah.
Dr. Disha Spath:
How are you?
Dr. Jim Dahle:
It's good out here, other than the drought we're having here in Utah. But I've been down at the lake. I spent last week at the lake, helping with the young women's camp down there and doing lots of fun stuff with them, driving the boat in circles as usual. It was going really great until one of those circles involved a rock. So, I ended up having to do an underwater propeller change, which is always good fun.
Dr. Disha Spath:
Oh my God.
Dr. Jim Dahle:
But I’m glad to be back in the studio today doing this with you. So, I had a shift this week, a busy shift. It was a lot of patients, a lot of hard work. Nobody too sick, thankfully. But it's always a good reminder to me to go into the ED and remind myself that everybody out there working hard, whether they're doctors, lawyers, physicians, dentists, pharmacists, whatever, you're doing something hard.
Dr. Jim Dahle:
That's why you get paid well. That's why you're a high income professional. That's why you're listening to this podcast, trying to figure out what to do with your money. But people probably don't tell you thank you very often. So, if you haven't heard it yet today, let us be the first. Thanks for what you do.
Dr. Disha Spath:
Thank you. You're awesome.
Dr. Jim Dahle:
All right. Let's see. This is July 7th when this drops. We're recording it actually on June 17th. I feel like I should tell people happy Juneteenth, but what I should really be telling them is happy Independence Day.
Dr. Jim Dahle:
But if you haven't heard, we are having a course sale. We've been having it for the last week and it goes for four more days. This is a 20% off sale on all of our online courses. They tell me it's an honour of my birthday, because the sale started on my birthday late last month.
Dr. Jim Dahle:
But between June 28th and July 11th we got a sale 20% off. All you got to do is go to whitecoatinvestor.teachable.com. That's where all our courses are. And when you buy the course, put in the coupon code BIRTHDAY2022. That gets you 20% off. 20% off is a huge discount for us. I think when we started Fire Your Financial Advisor, we had a one-week 20% off coupon, and that's the best deal we've ever had. We've never had it since then. So, this is really a pretty good discount if you've been waiting to take any of our online courses, be sure to check that out.
Dr. Disha Spath:
Oh, yeah. I love a good discount.
Dr. Jim Dahle:
Yeah. Everybody likes a good discount. It's interesting how many people email me all the time going, “When's the next sale?” I'm like, “Why would we tell you when the next sale is? Then you wouldn't buy it.” But here's a sale. So go buy it.
Dr. Disha Spath:
Jim, before we move on, how old are you going to be?
Dr. Jim Dahle:
I cannot tell you that. I'm too old to talk about my age anymore. But I can tell you this. I was looking at this goop be gone bottle. I was trying to get some crap off the boat that was stuck on it. And I had to ask Brett to read the label to me. So that tells you a lot about how old I am. Yeah. It was really painful.
Dr. Disha Spath:
Oh, that's sad. That's okay. That's okay. It just happened.
Dr. Jim Dahle:
Yeah. Before we get into reader questions, we got to talk about the markets. There's a lot of panic out there, even among White Coat Investors. A lot of people are trying to do crazy stuff, market timing and stock picking and shorting stuff and bailing out of their plans.
Dr. Jim Dahle:
As we record this like I said, it's June 17th, stocks are down 24% on the year and it's really convenient to this bear market actually to start right at the first of the year, it makes it really easy to look up the statistics. But what's interesting about it is bonds are also down thanks to the rising interest rates. Bonds in general are down 12% this year, which might be one of the worst years for bonds ever.
Dr. Jim Dahle:
Real estate as measured by publicly-traded REITs is down 24%. Now a lot of people think, “Well, my real estate is not down 24%.” Well, maybe that's just because it's not marked to market. Rising interest rates do have effects on the value of real estate.
Dr. Jim Dahle:
Of course, you could be worse. You could be in Bitcoin. That's down 71% as we record this. Ethereum is down 78%. Gold, that refuge in dangerous times is down 10%. And to make everything worse while all your assets are falling in value, inflation is up. It's going up at 8% to 9% per year on an annualized basis right now.
Dr. Jim Dahle:
So not a great time to be an investor. Last year everything was going gangbusters. This year it seems like everything is tanking. What advice do you have for our White Coat Investors out there listening, Disha?
Dr. Disha Spath:
Stay the course, take a deep breath. This is the time where we get to tax loss harvest. We'll be talking about that. If you want to take advantage, if you have extra money, this might be a good time to put it in. But honestly, I don't know. I feel like this is totally personal, but I feel like this is kind of a delayed pain.
Dr. Disha Spath:
This was going to happen at some point. We stayed it off during the pandemic with all the stimulus money that was going out, all of the things that we did to not crash during a worldwide pandemic. Some of that, it's going to have to play out a little bit. We can't just pretend that that didn't happen.
Dr. Disha Spath:
The Fed is raising interest rates, which is going to be good for us in the end. We don't want 8% to 9% inflation to rise and keep staying forever. So, I'm okay with this as long as I have a job and I have income that I can put into the market and I'm not trying to retire right now. I feel okay with it. It's going to recover hopefully sometime. Historically, things do recover. So, what do you think, Jim?
Dr. Jim Dahle:
Well, the nice thing about assets falling in value is it raises the future expected returns from it. The classic example is bonds. If you're going to own bonds longer than the duration of your bonds, higher interest rates are a good thing because it takes a few years, the length of the duration to make up for that loss in value you get when interest rates go up and everything after that is awesome. You're coming out further ahead than you would.
Dr. Jim Dahle:
So, while it hurts in the short term, in the long run, it actually helps your future returns. I don't think it's necessarily all bad. This is my fifth bear market since I started investing. This is part of what you do as an investor. You go through bear markets. On average, they happen every two to three years. Every two to three years on average you'll have a decrease in stocks of 20% or more. On average once a year, you'll have a decrease of 10% or more.
Dr. Jim Dahle:
You got to be used to this. If you're going to be investing for 30 years during your career and 30 years afterward, you're going to go through 20 bear markets. This is not an unexpected event. Your plan should incorporate this into it. And my plan is to keep my asset allocation steady in bull markets and bear markets, etc. And so, that's what I'm doing, and I find it gets easier and easier and easier with every bear market I go through.
Dr. Jim Dahle:
All right, enough about today's markets. I think everyone's pretty well aware that things are not going well for their investments, but we're going to talk about some other things that you might be able to do about it, as well as take your questions. I mean, this show is driven entirely by you guys. What you want to hear, the guests that you want to hear from, the questions you have, whatever you leave on the Speak Pipe tends to be what we talk about on the show.
Dr. Jim Dahle:
So, let's do a clarification, first of all. This is from episode 264. That was what? Six episodes ago. Where are we at here? What are we recording? Yeah, six episodes ago. Somebody wrote in “Like any savings bond, if you use EE bonds to pay for higher education you don't have to pay taxes on those earnings. That's the same between EE bonds and I bonds. However, what you may or may not realize is for a lot of our listeners, high earners, you don't get that. There's a phase-out on savings bonds for education.”
Dr. Jim Dahle:
So, if your income is more than a certain point, you don't get that benefit. That limit right now is at… Let's see, it starts at $100,800. Joint filers, it phases out between $128,000 to $158,000. For everybody else, if you're single, it starts phasing out between $86,000 and $101,000, essentially. So, for lots of our readers, that's not a benefit for you. So, we probably should have mentioned that. At any rate, now you know.
Dr. Jim Dahle:
All right, let's talk about tax-loss harvesting. Tax-loss harvesting, our subject of the day today. We got several questions about tax-loss harvesting. And no surprise, when markets go down people start wondering about tax-loss harvesting. So, we'll let this question off the Speak Pipe introduce the subject.
Speaker:
Hey, Jim. I'm a mid-career sports doc, living in the Southeast. First, I'd like to thank you for all you do to help doctors with their finances. You are truly one of the few trusted names in this space, and we appreciate you.
Speaker:
With the recent downturn in the market, I have a couple of questions regarding capital losses and tax loss harvesting. First, I understand that capital losses offset capital gains of the same counter year and that you can carry $3,000 a year forward to offset ordinary income.
Speaker:
Can you also use losses to offset capital gains in future years? For example, say I have $100,000 in capital losses at the end of 2022. It would take over 30 years to realize the full ordinary income benefit at $3,000 a year. Instead, could I use this loss to offset capital gains five years later? Say I realized $50,000 of capital gains in 2027. Could I offset this with my 2022 capital losses? And if so, do these same rules apply to crypto investing as well?
Speaker:
Going a bit further down the rabbit hole, would you consider a capital loss an asset? Could a large capital loss be considered a potential vehicle for asset protection? And finally, if one accumulates a large amount of capital loss and doesn't have a significant capital gain to offset, how is this managed with the estate planning? Thanks for your help.
Dr. Jim Dahle:
All right. Great questions. Tax-loss harvesting, let's start with the basics. First of all, a tax loss is never a good thing. You don't want to lose money. This is a bad thing to lose money. You shouldn't look forward to tax-loss harvesting. Some people are entirely too anxious and excited to get tax losses so they can lower their taxes.
Dr. Jim Dahle:
Remember the goal here is to have the most amount of money after paying taxes, not to pay the least amount of money in taxes. What tax loss harvesting is, is making lemonade out of lemons. It's letting Uncle Sam share in your pain. That's what tax-loss harvesting is.
Dr. Jim Dahle:
The idea behind it is you are selling an asset that has a loss in a taxable account. You don't do this in 401(k)s. You don't do this in IRAs. You don't do this in 529s or HSAs. Only your taxable account. You sell something. And when you do that, you are realizing a loss. You've lost money. You're recognizing to the IRS, “Hey, I lost a bunch of money on this investment.”
Dr. Jim Dahle:
And when you do that, the IRS says, “Okay, you can use $3,000 per year of that loss against your ordinary income. And you can use an unlimited amount of that loss against your capital gains.” And so, that's basically what a tax loss is. And people go, “Well, that's a cool thing. I can lower my taxes with it.” And they started getting creative with it going “Well, how can I grab that tax loss without selling low? Without buying high and selling low?” which is what you don't want to do as an investor.
Dr. Jim Dahle:
So, what they do, they came up with tax-loss harvesting. Where you get the loss, but you're not selling low. And the way you do that is you exchange from one investment to another. You're selling something with a loss and you're buying something very similar to it, but not in the words of the IRS, substantially identical. And then you get to claim a loss and you haven't changed your asset allocation. So, you're basically invested the same way you were before, but now you have the loss you can use on your taxes. That's what tax loss harvesting is and why you might want to do it.
Dr. Jim Dahle:
So let me go through the specific questions here that this listener had. One, there was a little bit of confusion about carrying it forward. He said carrying $3,000 forward. That's not the way it works. You carry them all forward. If you don't use them that year, you carry them forward, you carry them forward indefinitely. So that's not an issue. What the $3,000 is, is that's how much you can use against your ordinary income each year.
Dr. Jim Dahle:
Then he asked lots of really interesting questions. One's about crypto. Crypto, there's a loophole here for crypto. Normally when you are tax-loss harvesting stocks or mutual funds or bonds or whatever, you cannot buy back what you just sold for 30 days. If you do, that's called a wash sale, and your loss is disallowed. It's not like the end of the world. You basically just have your basis carried over to whatever the new thing you bought was. But you don't get to use the loss.
Dr. Jim Dahle:
So, in general, you try to avoid that. And that counts for a period 30 days after, as well as 30 days before. You can't buy the new thing and then sell the old thing the next day. They're onto you there. It's got to be 30 days apart between those two events.
Dr. Jim Dahle:
That doesn't mean you can't sell something you just bought. You just got to sell all of it. For example, if you bought a bunch of total stock market shares last week, and now you have a loss, you don't have to wait 30 days as long as you're selling them all. If you sell all your total stock market and exchange it for S&P 500 index fund or whatever, those two funds have a correlation of 0.99, they're going to perform essentially the same, but you book that loss, you are fine.
Dr. Jim Dahle:
But what you can't do is own a whole bunch of total stock market and only sell part of it and then buy some and then sell some more. They're onto you there. So, you got to be a little bit careful with the wash sale rule that burns a lot of people.
Dr. Jim Dahle:
The other thing that burns a lot of people quite frankly, is what's called the qualified dividend rule. And a lot of your investments pay out dividends and they're qualified dividends, meaning they're qualified with the IRS for a lower tax rate.
Dr. Jim Dahle:
And one of the rules in order for those to be qualified is that you have to own the investment for at least 60 days around the time of the dividend. So, if the dividend is paid out on June 25th, and you bought it on May 30th, and you sold it on July 4th, that's not 60 days. That dividend becomes unqualified and you pay taxes on it at your ordinary income tax rates, not the lower qualified dividend tax rates.
Dr. Jim Dahle:
So, this burns people when they're frenetically tax-loss harvesting, when they're tax-loss harvesting every two days all month, then they realize that they've given up more tax benefits by not getting the qualified dividend rates than they gain from the tax losses from tax-loss harvesting.
Dr. Jim Dahle:
Quite frankly, you probably ought to sit on your thumbs a little more often and only tax loss harvests every two or three months, even in a dropping market. So, don't get too carried away with it, or you may end up doing more harm than good.
Dr. Jim Dahle:
A couple of other interesting questions there. I thought that I don't think I've had anybody ask me before was whether there's some sort of asset protection benefit from having a whole bunch of tax losses. And I can't think of one. This isn't like having a big mortgage on a property where you've kind of stripped the equity out of the property. It's just a loss sitting there waiting for you to be able to use. But I wouldn't think of it as some sort of an asset that you could use for asset protection. It might help lower your future taxes. That's not going to protect from your creditors.
Dr. Jim Dahle:
Also, these all go away when you die. So, you don't pass these on to your heirs. The good news is your heirs get a step-up in basis when you die, but they don't get to carry forward your tax losses. So, as you can tell, the first $3,000 per year are really valuable. Some amount above and beyond that is pretty valuable. And at a certain point, it really doesn't help you at all. There is a limit to how useful tax-loss harvesting can be. But I understand you're going to be doing your first tax-loss harvesting here coming up, Disha.
Dr. Disha Spath:
Well, I'm trying to decide, honestly. I've been binging on all your articles and Physician on Fire's articles about this because honestly, well, you can't do it unless you have a brokerage account. And Josh and I just recently started investing in the brokerage outside of the retirement accounts. And now we can actually capture some of these losses, but my whole setup's been automation. And it seems that I would have to change a few things.
Dr. Disha Spath:
And I'm really excited that you are going over all of the details because I feel like a lot of us do this where we just invest a set amount every month and it does it automatically, and I reinvest the dividends. So, I think I would need to kind of look at all of that and make sure that I sell the ones that I just bought automatically, turn off the automation, and then also turn off the reinvestment of dividends and try to do that manually.
Dr. Jim Dahle:
Yeah. This is a big problem people have. I get this question by email all the time. They're like “I set it all up automatically like I'm supposed to.” Automatic investing and tax loss harvesting do not play well together. They just don't. It doesn't work well. It's great to reinvest your dividends. It does create a lot of tax lots to keep track of when you do that. So, I'm not really a fan of doing it in your taxable account. And it's great to automatically invest every week or every time you get paid or whatever. You get that money in the market, it's working right away. You end up getting the benefits of this periodic investing and you end up doing really well in the long run.
Dr. Jim Dahle:
It's really a great strategy. It just doesn't play well with tax-loss harvesting. So, what I end up doing is I take all the money I made that month, whatever it is, whether it's from dividends or whether it's from real estate rents, whether it's from my clinical practice, whether it's from WCI, whatever. And I look at it once a month and I invest it manually. I don't actually do any sort of automated investing.
Dr. Jim Dahle:
Early in the year, it's going into 401(k)s and Backdoor Roths and HSAs and the kids UTMAs and 529s and that sort of stuff. Later in the year, it tends to all go into taxable. But I've essentially given up the benefits of automating everything in order to have a little more control over my taxes.
Dr. Jim Dahle:
Whether that's right or wrong, it's hard to say. There are people out there that just don't feel like tax-loss harvesting is worth the effort. I mean, if you think about it, if you're only getting the $3,000 a year, that's only about $1,000 off your taxes for most docs, it's not a huge amount.
Dr. Jim Dahle:
And the truth is for lots of people, if they end up selling those shares eventually, they're only delaying the payment of the taxes on their long-term gains. Which, there's a benefit there, but it's not a huge benefit unless you're somehow flushing the capital gains out of your portfolio like I do with charitable giving. Then you're just kind of delaying when you pay those taxes. So, there's a pretty good argument to be made not to tax loss harvest at all. But I think it's worthwhile. I combine it with charitable giving and it becomes very powerful for us.
Dr. Disha Spath:
That's awesome. And I think a little bit also has to go with your self-awareness of how well you're going to do if you do turn off the automation, especially in this kind of a down market where if the investment becomes optional every month, then are you going to stop investing?
Dr. Jim Dahle:
Right. Exactly.
Dr. Disha Spath:
So, you really need to know your behavior.
Dr. Jim Dahle:
Yes. It’s the classic behavior versus math thing. I mean, mathematically, you can make a pretty good case for tax-loss harvesting. Behaviorally, automating things is really powerful. It helps a lot of people to become millionaires and just putting things on automatic autopilot and going about their lives. I mean, how much time do you want to spend on your finances? You got to ask yourself that when you start looking at things like tax-loss harvesting, like so much.
Dr. Jim Dahle:
Like all the real estate investing we talk about here at the White Coat Investor. It's optional. You don't have to do it. You can become a financially independent multimillionaire without investing in real estate at all. And tax loss harvesting is kind of the same way. It's optional. You don't have to do it.
Dr. Jim Dahle:
All right, let's look at our next question. This one is also on tax-loss harvesting. It comes in via email. Do you want to read that one, Disha?
Dr. Disha Spath:
Sure. “How about a deep dive into tax-loss harvesting and wash sales? Not just the basic rules, but the intricacies of what could trigger a wash and how to avoid it and case examples of that.
Dr. Disha Spath:
The second thing that could be discussed is whether municipal bond funds or ETFs can be tax loss harvested. A third thing could be discussed is the tax treatment for home improvements or special assessments by condominium and how they should be accounted for.”
Dr. Disha Spath:
So, do you want me to read them all right now, Jim, or you want to go take them one by one? Because there's a lot here.
Dr. Jim Dahle:
Why don't we take them one by one? Because there's lots of questions in this email.
Dr. Disha Spath:
Yeah. This is good.
Dr. Jim Dahle:
Well, let's take the second one first. This one's easy, right? You can tax loss harvest bonds. Up until this year, I'd never tax loss harvested bond funds or ETFs. This year I've already done it twice. I probably need to do it again.
Dr. Jim Dahle:
Typically, bonds don't lose as much money as they've lost this year. And so, it's kind of presented a unique opportunity. You do it exactly like stocks. You find a similar bond fund or ETF, and you exchange for it. You sell one, you buy the other one, no big deal and you get the tax loss. Yes, no reason you can't do it with bonds. It's typically not done, but I'm doing it. So, no reason you can't.
Dr. Jim Dahle:
All right. Let's do that condominium one too. That one's pretty easy actually. Tax treatment for home improvements, special assessments by condominium, etc, those all add to your basis.
Dr. Jim Dahle:
So, they don't give you any sort of deduction this year. What they do is they can help you potentially when you go to sell the property. Now, a lot of times you're not paying capital gains when you sell a property because you're within the exemption amount. It's $250,000 single, $500,000 married. If you've gained less than that on your home, you don't pay capital gains when you sell your residents.
Dr. Jim Dahle:
But if you were above that amount, this amount you added with home improvements, with special assessments by condominium, or the big renovation we did a couple of years ago on our home, I kept the receipts. Because I want to be able to add that to the basis of what I paid for the home should I ever sell it. And I don't want to pay taxes on that amount. So, that's all you get for home improvements.
Dr. Jim Dahle:
On investment property where you're more likely to be paying some gains, it helps more significantly than with your residence.. But it's worth keeping track of them, just don't expect a lot of benefit for it I think most of the time.
Dr. Disha Spath:
What about the interest from it? Like if someone took out a HELOC and the interest they were paying on that? Is that deductible for a home improvement project?
Dr. Jim Dahle:
It depends. Yeah. That's exactly it. For the home improvement project, it is. I think it's up to $100,000 is deductible. If you take it out and use it to buy a wake boat or to go heli-skiing, it's definitely not deductible. Now money is fungible. So, I don't know how closely they're really looking at that, but those are the rules. The interest on the first $100,000 of the loan is deductible. So, that's helpful.
Dr. Jim Dahle:
Okay. Let's talk about some case examples.
Dr. Disha Spath:
Yeah. The intricacies and some case examples.
Dr. Jim Dahle:
Yeah. And mostly its people getting burned by wash sales, because they're doing them too fast. If you just slow down, all those questions go away. You don't have to get burned by the 60-day rule. You don't have to get burned by the 30-day wash sale rule. Just chill. You're going to have enough losses in your life if you have a taxable account of any significant size to always get your $3,000 a year and to have significant other losses for whatever you might need them for. So, I don't feel like you got to get all these losses in one year. I totaled up the number of tax losses we've got saved up right now. I think we're at three quarters of a million dollars.
Dr. Disha Spath:
Wow.
Dr. Jim Dahle:
I mean, how many years is that? 250 years at $3,000 a year. I would've stopped accumulating them a long time ago if I didn't think there was a possibility of selling the White Coat Investor at some point down the road. That's the only reason I'm still picking these things up. Otherwise, I would just let it go.
Dr. Jim Dahle:
You only need so many. So chill, you're going to get the losses. Don't worry about that. They will come and you don't have to go hire a robo-advisor to get every single dollar anything ever drops. If you're a high-income professional and you're building this taxable account, you're eventually going to have enough money in there that any reasonable downturn that's going to happen every two or three years, you're going to grab some significant losses with. So, don't panic so much on that.
Dr. Disha Spath:
Yeah. Jim, I'm so sorry to interrupt you. I wanted to ask you. You were talking brokerage when you're talking tax-loss harvesting, but wash sales also include the transactions you're making in other accounts, right? Some other accounts. Which other accounts are those exactly?
Dr. Jim Dahle:
Well, the IRS is very specific about it. It counts in IRAs, but it does not count in anything else. So, you can't sell something in your taxable account and buy it the same day in your IRA. That's technically a wash sale. Now, is the IRS going to catch it? Almost surely not, because your taxable account and your IRA are probably at different places. If the broker doesn't report it as a wash sale, nobody else is going to catch it as a wash sale, but that's the law.
Dr. Disha Spath:
Okay.
Dr. Jim Dahle:
Some people have speculated, maybe that applies to 401(k)s too, but there's really no evidence that it does. The IRS has not specified that. So, there's nothing really keeping you from selling something in taxable, buying it in your 401(k).
Dr. Jim Dahle:
But honestly, come on, how hard is it to find a tax-loss harvesting partner with a correlation of at least 0.99 in your taxable account? It's not that hard. There are dozens. From what most of us hold in our taxable accounts, there's a dozen tax-loss harvesting partners.
Dr. Jim Dahle:
If you're holding a total international stock market fund or you're holding a muni bond fund, or you're holding a total stock market fund, it's not like it's hard to find something to switch into. You don't have to play these games with your other accounts.
Dr. Jim Dahle:
But your HSA doesn't count, your kids' UTMAs don't count, 529s don't count, 401(k)s, 403Bs, 457Bs, whatever they're doing in your cash balance plan, that doesn't count against your tax-loss harvesting, but you can't do it in your IRAs. You can't sell one in your IRA and buy it in your taxable account, etc. That could cause a wash sale.
Dr. Disha Spath:
Interesting.
Dr. Jim Dahle:
What other questions did he have in this lengthy email? Let's see.
Dr. Disha Spath:
Okay. I think that took care of the different accounts. All right, next one. “Regarding tax lost harvesting, I think it's important to get into the nitty-gritty. For instance, what counts as like accounts.” We just talked about that. “Obviously, if I have something in my tax advantage account, I can't cover for my taxable account, but what about UTMA exposures?” Jim just said that doesn't matter. It's only IRAs.
Dr. Disha Spath:
“Also, what if you sell fully out of a position versus just a single lot?” I think there are a lot of subtleties to that. Yeah. So, let's talk about lots and how do you even see that in Vanguard?
Dr. Jim Dahle:
Okay. If your taxable account is at Vanguard or you can do this at Fidelity or Schwab or wherever you are. You go in there and you click on their cost basis tab and it'll give you an option, unrealized gains, realized gains and something else. Just click on the unrealized gains. And then there's a little button there underneath each holding that you can click on. And it shows you all your tax lots.
Dr. Jim Dahle:
And Disha, you'll notice this. When you go in there because you've been reinvesting your dividends, you're going to have some big tax lots, and you're going to have some little tiny tax lots that are maybe just a few dollars, whatever the size of that dividend was.
Dr. Jim Dahle:
But all your tax lots will be listed there. And it will show you what the gain or loss is on that lot. Whether it's short term, whether it's long term, whether it's a gain, whether it's a loss and you can then choose which of those lots you want to sell. So, you click the ones basically that have losses and you sell those. You don't have to sell everything. But you can just sell those lots and then buy something similar to it.
Dr. Jim Dahle:
In my case, I tend to go from a Vanguard total stock market ETF to an iShares total stock market ETF. They're different holdings, they have different CUSIP numbers, different numbers of stocks in them even though they're very highly correlated. And so, I don't expect any different investment performance out of them, but they're not substantially identical. And so, that's what I would do with those lots.
Dr. Jim Dahle:
Now, when you get burned on that is when you're trying to do this frenetic tax-loss harvesting, and you're doing all these different transactions inside the same month. You got to be careful because if you've just bought something that can cause a wash sale, unless you also sell what you just bought.
Dr. Jim Dahle:
So, let's say you're investing automatically like you do, Disha. Let's say you're putting $2,000 a month into this total stock market fund. On the first of the month, you bought $2,000 of it. And at mid-month you're like, “Wow, I've got a loss on four lots, my last four months’ worth of purchases of this holding. I'd like to tax loss harvest it.” That's fine. You go back and you sell those last four lots. You just have to make sure that one of those lots is the one you just bought within the last 30 days. As long as you're selling that, the loss counts, there's no wash sale.
Dr. Disha Spath:
Got it.
Dr. Jim Dahle:
You can turn around then and buy the iShares version of it or whatever. And you're fine. You've booked the loss. You're not going to have a wash sale.
Dr. Disha Spath:
Got it. I actually logged in today and I was really confused initially, because I was like, I'm only seeing average prices. I just saw VTSAX average price this, and this was your total loss. But I wasn't seeing the tax lots. And there was just a cost basis method setting in Vanguard where instead of using the average cost, you have to switch it to special identification and then it shows you the lots. So, thank you for mentioning that.
Dr. Jim Dahle:
Yeah. That's a good point actually.
Dr. Disha Spath:
Thanks. Yeah.
Dr. Jim Dahle:
It's really important.
Dr. Disha Spath:
Yeah. Because after that I saw the lots and I was like, “Oh, okay, now I know which ones to sell should I choose to do this.” So, that's important.
Dr. Jim Dahle:
Yeah. That's actually really important. Specific identification is what you want. They give you all these things. First in, first out. And I don't know what it is, last in, last out and average cost basis. You always want specific identification. So, every time you buy a new holding in your taxable account, choose the way they're going to keep track of the cost basis for you and what you want is specific identification.
Dr. Jim Dahle:
When you go to sell those lots, whether you are tax-loss harvesting, or whether you're selling them in retirement to pay for living expenses, you want to be able to pick which lots you sell. Because in retirement, you want to pick the ones that are going to cost you the least amount in taxes, ones with the highest cost basis. And obviously, when you are tax-loss harvesting, those are the ones you typically sell as well. So that's a really good point.
Dr. Jim Dahle:
All right. The questioner gives an example in this email. “What if I hold VWO?” That's the Vanguard. I don't know which one that is. I think that's the Vanguard emerging markets ETF. “Then I sell all shares of VWO and switch into IEMG.” I think that's the merging markets, iShares, ETF.
Dr. Jim Dahle:
“IEMG then goes down significantly over the course of 20 days or so under the 31-day requirement. Then I sell out of all my position of IEMG at that 20-day mark.” That's great. You get the loss from that as well. “But I don't buy into VWO until 30 days have elapsed since I was in VWO.” I might wait 31 days just to be sure. But yeah, that works.
Dr. Jim Dahle:
“Since I sold out of the full IEMG position, can I take that as a loss too?” Yes. “Also, if you have a taxable gain in a real estate sale, can an unlimited amount of carry forward investment taxable account be used against that?” Yeah. If it's a capital gain, if you have a capital gain from real estate sales, you can use losses from your taxable investing account. You can book all these losses on mutual funds and you can use them on real estate capital gains. You absolutely can do that.
Dr. Disha Spath:
Cool.
Dr. Jim Dahle:
All right, let's take our next email question. This one's also broken into four questions. Do you want to read this one, Disha?
Dr. Disha Spath:
Absolutely. “I am a second-year medical resident about to book $9,000 in tax losses for harvesting. I'm wondering if I can hold these losses for several years until I'm in a higher tax bracket, start working as an attending, or if I have to use the $3,000 annually plus capital gains tax offsetting.”
Dr. Jim Dahle:
I just laugh at this question. First of all, you're doing awesome. If you have enough money in a taxable account as a resident to lose $9,000, you're awesome. I didn't even have a taxable account. I didn't have a taxable account for most of my career.
Dr. Disha Spath:
It's great.
Dr. Jim Dahle:
I had it very briefly when I was in the military, ended up giving it away to charity, the entire account. We used it for our charitable donations one year. Started again, I don't know, five or six or seven years ago, something like that.
Dr. Jim Dahle:
So, I'm pretty amazed that a resident even has a tax account. What that tells me is you're maxing out your 403(b), your Roth IRA. If you have a spouse, their accounts, and you're still investing enough that you can lose, I mean, it's great. Congratulations. You're doing awesome.
Dr. Jim Dahle:
But the other funny part about this question is they're worried they're never going to have another loss. “Oh, I got to save this loss. I'm never going to get another one. Stock market is never going down again.” Use the loss. Just use it. Just use it.
Dr. Disha Spath:
Well, I think we talked about this earlier, Jim. I don't think there's any way to fill out that form to not use that loss. If it's there, you have to account for it.
Dr. Jim Dahle:
Yeah. You can't carry it forward. You're right. When you fill out the form. The same form you use to use the loss is the form you use to carry forward the loss. It's your Schedule D on your taxes. So, it's not like you can save them in your pocket and use them later. You can't do that. So, you wouldn't want to anyway, just use them.
Dr. Disha Spath:
Okay. All right.
Dr. Jim Dahle:
All right. What's his next question?
Dr. Disha Spath:
Next question. Yeah. “In the same context, I am in the 0% long-term capital gains bracket, but have some annually accruing realized capital gains for my mutual funds. Do the tax losses get used up, even though I'm not paying taxes on let's say, $1,000 in long-term capital gains?”
Dr. Jim Dahle:
That's a good question. Do they get used up? Yeah, I think they do. I'm sorry you're in the 0% tax bracket. It must be terrible.
Dr. Disha Spath:
Good problem.
Dr. Jim Dahle:
But yeah, if you've got capital gains, I think they're wiping out capital losses. Even if you're in the 0% bracket. I would have to work through the taxes to make sure on that. I'm not 100% sure, but I think that's the way it works is that losses offset gains on Schedule D and then after that they figure out which bracket you're actually in. So, I think you are using them up, even if you're in the 0% bracket, but I'm not 100% sure.
Dr. Disha Spath:
Okay. “Could you theoretically tax-loss harvest enough to negate all the capital gains tax you have when you start retirement or whenever you start selling assets?”
Dr. Jim Dahle:
I guess. Yeah, you could. It's all about how many gains you have later. Hopefully, you don't have enough losses to negate all your capital gains. Because that means you're coming out behind. Now, the exception, of course, is if you're doing what I'm doing, where you take your really appreciated tax loss and you use those to give to charity, then you could accumulate losses far in excess of your gains.
Dr. Jim Dahle:
But for most people, if you have more losses than you have total gains in that account, you've lost money. You are not investing well. And if that happens over decades, you've really kind of botched your whole investing strategy. So, that's not a good thing, but it's possible. In reality, what happens is you've booked these losses as you go throughout your career. All your stuff has gained and gained and gained throughout your career and you get to retirement.
Dr. Jim Dahle:
And you're like, “Oh, my dividends and my social security and my pensions aren't going to cover what I want to spend this month. So, I'm going to sell some assets.” And you turn around and go, “Well, which assets am I going to sell?” Well, I'm going to sell the ones with the highest basis and maybe 90% of the value of what you're about to sell is basis. Well, you don't pay taxes on basis. You only pay taxes on gains. So, you might pull out $50,000 out of that account and only have to pay taxes on $5,000 of it.
Dr. Jim Dahle:
Now, if you're carrying around a quarter-million dollars in tax losses, that comes out tax-free. It's just like a Roth IRA withdrawal. So, for many years, many of the first few years, you probably don't have to pay. If you've been diligently tax-loss harvesting, you probably don't have to pay any capital gains on that money for quite a while.
Dr. Jim Dahle:
But eventually, you're going to run outta those high-basis shares. And eventually, you're probably going to run out of those tax losses and have to pay some dividend taxes. But that's not such a bad thing.
Dr. Disha Spath:
That sounds like a total workaround. That sounds like a total loophole that I want to take advantage of. But yeah, it is going to require some work.
Dr. Jim Dahle:
Yeah. You have to book them as you go. For sure.
Dr. Disha Spath:
Yeah. So, as you book them, the next question is, “How do you keep track of losses over the years? Do you save them on Excel?”
Dr. Jim Dahle:
I don't. I save them on my tax form. Your Schedule D. Every year your Schedule D totals it up and at the bottom of it, it's got, well, this is your total amount of tax losses you're carrying forward. So, I think last year I was carrying forward $365,000 in tax losses.
Dr. Jim Dahle:
And obviously, this year has not been good to us. And so, I got a whole bunch more tax losses. And so, next year when I get to the bottom of the form, it'll say something like $800,000 in tax losses, and I'll use $3,000 against my ordinary income. And if I have any gains for whatever reason this year, then I may use some of those up. But everything else will be carried forward.
Dr. Jim Dahle:
And so, that's just the way it works. It just goes forward from one Schedule D to the next, no reason to open an Excel file, unless you are worried you're going to lose your tax forms, I guess. But since you got to keep them for seven years, it doesn't seem that hard to keep last years.
Dr. Disha Spath:
Sounds good. All right. Let's do the next Speak Pipe.
Dr. Jim Dahle:
Yeah. If we beat the subject to death, is there anything else we can possibly say about tax-loss harvesting? I guess we could come up with even more wash sale intricacies, ways people create wash sales because they're trying to tax less harvest every three days all month. But it seems a little overkill. Just stop doing that. Just tax less harvest every two or three months and you'll be fine.
Dr. Jim Dahle:
All right. Let's listen to this one. It sounds like we're going to talk about loans.
Speaker 2:
Hi, thank you for all the wonderful resources. I'm a recently graduated MD PhD student that matched into a dermatology program in the East Coast. My wife and I are looking to buy a house in the $400,000 to $500,000 range for my residency training and potentially beyond.
Speaker 2:
With my wife’s resident salary, we'll make a combined income of $150,000 to $160,000 and we have saved $100,000 for a down payment. All the credit goes to her. We have excellent credit scores in less than 30% debt-to-income ratio given that my program provided complete tuition remission.
Speaker 2:
Would you advise us to take a physician loan so that we have more fluid money or do a conventional loan with 20% down but that means a little bit more difficult leaving? Thanks again.
Dr. Jim Dahle:
There's no right answer to this question. This is a classic question. The first thing I ask is, “Do you really want to buy a house at all?” You're going into residency. You didn't mention how long your residency is, but on average it takes about five years to make buying the right decision. And lots of residencies are only three or four years long.
Dr. Jim Dahle:
So, for lots of people, no matter how much money they have saved up, no matter how much their spouse makes, the right answer is to rent. That's question number one is “Should you be buying in the first place?” I'm assuming that you have already thought through this and for whatever reason have decided you're buying, whether you just don't care or you couldn't find a decent place to rent, or you're going to be there for many years or whatever reason you're going to buy anyway. So, hopefully you have considered that.
Dr. Disha Spath:
Can I chime in?
Dr. Jim Dahle:
Absolutely.
Dr. Disha Spath:
No, I was just going to say one other thing I would add, a good reason to buy a residency house would be if you are actually looking into real estate investing and you want to buy a house that you want to later keep as a real estate investment and rent it out. That's one way I've seen a lot of physicians do well in buying a resident house. You have to actually buy the house that's going to rent out and make sense in the numbers and cash flow. That's the caveat.
Dr. Jim Dahle:
Yeah, exactly. I'm going to push back on that for two reasons. The first one is lots of people leave that area. And now you're a long-distance landlord. And those of us who went through residency in the early 2000s and then came out and couldn't sell houses, or late 2000s rather, couldn't sell your place because nothing was selling in 2009, 2010. And you were forced to keep it as a rental, often at a loss and while you lived in some other city. People were not very happy about that. That did not end well for them. So, you got to keep in mind, are you willing to be a long-term landlord if you do that?
Dr. Disha Spath:
Right. And if that's in your plan. Yeah.
Dr. Jim Dahle:
Yeah. And you're right. The other point you made is that people don't buy the houses they live in, the same way they buy their rental properties. When you go to buy this house, you want to live in, you're like, “Oh, what's the school district? What's the colors on the walls? Is the backyard perfect for my dog?”
Dr. Jim Dahle:
When you buy a rental property, it's about the numbers. What's the cap rate? What's my net operating income going to be? It's a little bit different calculus. And if you're willing to buy the place you live in for three or four or five years by the numbers, I think that can work out. Lots of people do get their start real estate investing that way. But you got to do it as a real estate investment from the beginning.
Dr. Jim Dahle:
Okay. Enough of that preamble. Let's talk about conventional loan versus physician loan. A physician loan is 0%, 5%, 10% down instead of 20% down. You get to avoid private mortgage insurance either way. It's just a question of, “Do you have a better use for that down payment or not?”
Dr. Jim Dahle:
My recommendation when you buy a home is that you keep your mortgage to less than two times your gross income. And the only way this couple is going to do that is by using that down payment. If they want a $400,000 or $500,000 house, and they're only making $160,000, they got to put some money down in order to keep that under 2X. So, that's probably what I'd do. I'd put the money down in that case.
Dr. Jim Dahle:
But if you feel like you just have these awesome investments or you got 8% student loans you want to put the money on, or you got some much better use for your money, then I think you can do that. It's not the end of the world to use a physician mortgage loan. They'll certainly give you one. There's no doubt about that. You're going to qualify for one. I don't think that's going to be a problem. It's just a question of what you want to use your money for.
Dr. Jim Dahle:
I think I'd put it down on the house if I was set on buying this particular house. How about you, Disha? What would you do? Would you invest it or would you put it down given their numbers?
Dr. Disha Spath:
Yeah, it totally depends. Their numbers, like you said, I think the mortgage amount would be too much without putting it down at their income level right now, as residents. Of course, when they're attendings it'll be a totally different story. But they're looking to take on a decent size mortgage to do that. But if I was going to buy a house as a real estate investment, the less you put down, the better you do number-wise from a cash flow perspective, or rather from a return perspective, not from a cash flow perspective.
Dr. Jim Dahle:
Yeah, not from the cash flow. Cash flow is worse.
Dr. Disha Spath:
Exactly. Yes, exactly. But if you have a higher mortgage, obviously, you're going to have lower cash flow, but you get a higher rate of return of your money. If you don't put anything down, obviously.
Dr. Jim Dahle:
Assuming the house appreciates.
Dr. Disha Spath:
True, assuming it all works out in your favor. Of course. And it's a good investment.
Dr. Jim Dahle:
Right. Leverage works. Leverage works for sure.
Dr. Disha Spath:
Yeah, exactly. But we have to realize this is leverage. You take risk. If you don't put down the cash, the more mortgage you take on, the more risk you're taking on. And it depends on how much risk you're willing to take on, on your primary home. And it depends on how much risk you're willing to take on overall. And what stage of life you're on. There's a lot that depends in this.
Dr. Jim Dahle:
Yeah, for sure. All right. Let's do our quote of the day today. Henry David Thoreau, one of my favorites. “The man is the richest whose pleasures are the cheapest.” And there's a lot of truth to that. And nobody had cheaper pleasures than Thoreau.
Dr. Jim Dahle:
All right. Let's talk about this side gig email. Here's an email that came in just a random podcast blog idea. “What about something on getting your finances together when starting your side gig? There's lots of talk on the podcast about side gigs, expert witness, etc. And I feel like a good portion of your listeners are primary W2 earners, but have some small amount of 1099 income either for themselves or a spouse.
Dr. Jim Dahle:
Granted each person's financial situation is different, but I think there's also a lot of overlap. Practical example, I think of my wife, a urologist who made about $20,000 last year in 1099 income from serving as a consultant for a medical device and pharmacological drug.
Dr. Jim Dahle:
Simple things like tracking expenses, what can be deducted, organizing paperwork per diems when traveling, contract review for the 1099, managing risk exposure, etc. For example, looking back, I wish she had a separate credit card for all of her 1099-related expenses and used a smartphone app.
Dr. Jim Dahle:
In summary, you landed a 1099 side hustle, now what?” Well, how would you advise somebody, Disha? We both started businesses. That's what we're talking about here, is starting a business. What are the basics of starting a business? That's what they're asking.
Dr. Disha Spath:
Yeah, absolutely. I think that makes a lot of sense, what he mentioned with a separate credit card. That's what I did when I started my LLC. I got the EIN and then I used that to open a separate checking account and credit card. That way I could keep those expenses completely separate from my personal expenses for accounting purposes. And then I use a web-based platform to do the accounting for me in those two accounts. That does help a lot in the year-end or quarterly now tax payments that we have to make. What about you, Jim?
Dr. Jim Dahle:
Yeah, not that complicated. You get an EIN, that's free. It takes 30 seconds online. Just Google “Get EIN” and it’ll take you to the IRS website and give you one. I agree. Separate bank account, separate credit cards, it’s pretty helpful.
Dr. Jim Dahle:
What are the things were they asking about? I tended to just keep books for really simple business in Excel. I found that pretty easy, but as it gets more complicated, most people transition to something like QuickBooks. That's what we use for WCI now.
Dr. Jim Dahle:
Yeah, you got to keep track of your expenses. Any business expense can be deducted. The tricky one is meals. Because you can only deduct half of your meals and entertainment. If you're entertaining somebody for your business, that's only half deductible. So that gets kind of tricky. Per diem, if somebody else is paying it, obviously it's not a deduction for you. You don't pay yourself per diem. You just deduct the expenses.
Dr. Jim Dahle:
Should you get a contract review? Yeah, you probably should get a contract review if you've got some sort of a complicated contract for that 1099 thing, just like you would any W2 job.
Dr. Jim Dahle:
Managing risk and exposure. If there's some significant business liability, it's worth forming an LLC. If you're just moonlighting, the LLC isn't going to protect you from your main risk, which is malpractice. So, I don't see any point in starting that unless you're going to try to file as an S Corp or something and trying to save Medicare taxes.
Dr. Jim Dahle:
But that's kind of the basics of starting a business. Make sure you pay your quarterly estimated taxes. That's probably the most complicated thing for people. If you're only making $20,000 and you've got a physician kind of income on the side, you're probably withholding enough from the W2 job that you don't have to make additional payments. But if you make $200,000 in your side gig, you'd better be planning to make significant quarterly estimated payments every quarter to stay up with the IRS. It's a pay-as-you-go system, right?
Dr. Disha Spath:
Absolutely. Cool. Good question.
Dr. Jim Dahle:
Okay. Yeah. Let's skip this next one in the interest of time and let's go straight to the 529 question from Murray.
Dr. Disha Spath:
Okay.
Murray:
Hi, Dr. Dahle. This is Murray from Los Angeles. Thank you for all that you do. I have an observation and a question regarding 529s. This year was my first-time making withdrawals. And I was surprised that in filing the 1099-Q, I was expecting to have to prove somewhere that the number in box one, the total distributions, would have to be followed up somewhere with your documentation or proof on how much of that is qualified.
Murray:
I was surprised when this wasn't the case, and when I looked into it in the WCI forums, the recommendation was to just tuck your 1099-Q form and any relevant documentation in your tax folder. So, in reality, it seems you only have to show your distributions are qualified in the event that you are audited, I suppose.
Murray:
My question regards timing the withdrawals. I was thinking that with the market being what it is currently, and right now it's early May, I might pay the first set of tuitions out of cash stores to give my 529 some time to recover.
Murray:
What is the latest that I can withdraw the money? The same calendar or tax year in which I paid the bill or the same fiscal or academic year? I can't seem to find this clearly documented anywhere. I would obviously prefer the latter and that gives a little more time for things to potentially recover. Thank you.
Dr. Disha Spath:
Yeah. You're totally right. We're on an honor system with a lot of the tax code. We report the stuff that we spend on, but if you get audited, you better have the proof. So that's why you need to just save the receipts and save all the proofs of payment. Now, I believe for 529 withdrawals you have until the end of the calendar year. Right, Jim?
Dr. Jim Dahle:
Yep. That's absolutely right. We're withdrawing for the first time this year in 2022. Whitney is starting college. And she came to me going, “I got to get some money out of my 529 to pay tuition” And I'm like, “Well, when's tuition due?” And it wasn't due for a few more months. And I'm like the market is down a little bit. Maybe we let it recover a little bit before we take it out. And so, of course, the market has continued down. We should have taken it all out a couple of months ago and paid tuition months early.
Dr. Jim Dahle:
But that's fine. Our whole plan is to keep it invested aggressively and take advantage of that over the long run. We're only pulling out a tiny percentage of what's in there anyway to pay tuition right now. But yeah, that's the way it works. You have to the end of the year if you want to pay in cash and wait until December 25th to pull all the money out. Well, maybe not December 25th because the market will be closed, but the 27th or something, then you can do that. Nothing to keep you from doing that.
Dr. Jim Dahle:
All right. Let's take one on a UGMA account from Amy.
Amy:
Hello, Dr. Dahle. First off, I wanted to say thank you for this community. My husband and I met when we were both just out of residency. And I found out on our first date that he also read your blog. I think that helped him get a second date and the rest is history.
Amy:
Anyway, my question for you. I was the very fortunate minor in a UGMA account that my grandparents contributed to when I was a young child. The money was invested by my father in a few Vanguard actively managed value funds. I sold a chunk of the funds to pay for college and medical school, but I also received some scholarships and lived very frugally while I was in school. So even after those expenses, I still had money left over.
Amy:
The first world problem that I am facing now is the tax inefficiency of these funds. The expense ratios are 10 times higher as compared to the ratios of the low-cost funds and ETFs I'm using now. Also, as value funds, they give off a decent amount of dividends and capital gains of about $30,000 to $40,000 a year, which I pay taxes on, but I don't take the money out. So, it's a little painful to pay taxes on money I don't really appreciate as income.
Amy:
I'm also young in my career and I don't really need passive income at this time. If I were to sell the funds, I'd have to pay capital gains on about $140,000, which is painful. So, I'm wondering what the best thing to do is with these less-than-ideal funds. Thank you.
Dr. Jim Dahle:
All right. Well, congratulations to you, Amy. This is indeed a first-world problem. If you have enough money left to you that it now kicks out $30,000 or $40,000 a year in dividends, this is a substantial account we're talking about. This is hundreds of thousands of dollars. So, congratulations to you. That's wonderful. It's a great problem to have.
Dr. Jim Dahle:
I do empathize with your tax concerns. The only thing worse of course, than paying taxes is not having to pay taxes because you don't have the income. So, this is not all bad. And I wouldn't even call it a UGMA account anymore. I mean, this is just your taxable account at this point. Once you hit age 18 or 21 or 25, depending on the state, it just becomes your taxable account.
Dr. Jim Dahle:
So, you have legacy holdings is what we cause this. Something that you wouldn't buy today, but that you don't want to sell because the tax consequences are so painful. And the way you deal with these things, if on some of them you have a loss, well, you just sell it. It's just like tax-loss harvesting, a great opportunity to get out. If there's not much of a gain, again, you can sell it. No big deal. If you have a bunch of tax losses saved up from something else, you can use those to offset your gains and you can get into the portfolio you'd really rather hold.
Dr. Jim Dahle:
But if you're in the situation that you're in, where this is a large amount of money with a large amount of gains that you don't want to pay taxes on, then what you end up doing most of the time is building your portfolio around it. And that's fine. These are Vanguard funds, they're value funds. Although yes, the expense ratio might be 10 times what an index fund is. They're probably still only 0.3. So, these are well below-average expense ratios. This is not a terrible thing to hold in your portfolio long term.
Dr. Jim Dahle:
Jack Bogle himself had lots of these sorts of holdings in his account that he wasn't about to sell because of the tax consequences. So, don't beat yourself up about it in any way, shape or form. Just take advantage of it. It's great to have the income, even if you're paying taxes on it as you go along.
Dr. Jim Dahle:
Now, maybe you don't want to reinvest those dividends. Maybe you have them paid to you, and that way you'll have the money to pay the taxes on them. And then if there's extra, you can reinvest that or do whatever you want with it.
Dr. Jim Dahle:
Here's another suggestion. Something I would consider doing, because we give a lot of money to charity. If you also give a lot of money to charity, these are the shares you should use to give to charity first. They're something you don't want. They're highly appreciated. You don't want to pay capital gains on them.
Dr. Jim Dahle:
If you either give them directly to a charity or give them to a charity via a donor-advised fund, you basically wipe your slate clean of these capital gains. And instead of giving cash, you're giving these appreciated shares, and then you can buy what you want with the cash. So, that's also a great way to do it. If you're not a charitable person that might not work out very well, but if you are, this is a great way to get rid of legacy holdings.
Dr. Disha Spath:
Good point. That's a great point. Thank you, Jim. I appreciate you really telling us about donor-advised funds and reminding us that that is also an option. And thank you for asking this question, Amy, because this is something that's very relevant to a lot of White Coat Investors.
Dr. Disha Spath:
Thank you so much for listening. Let me also just talk about our sponsors because they're very important to this show in keeping us going. Alexis Gallati, a founder of Cerebral Tax Advisors has nearly two decades of experience in high-level tax planning strategies and multi-state tax preparation. She's also the author of the book, “Advanced Tax Planning for Medical Professionals.” She grew up in a family of physicians and is married to one.
Dr. Disha Spath:
Cerebral Services are a flat rate and they are focused on their client's return on investment. If you'd like to find out more or schedule a free consultation, visit their website at www.cerebraltaxadvisors.com
Dr. Jim Dahle:
Something else we want you to check out. If you are interested in turnkey investing, meaning you want to own a rental property, but you don't actually want to do any of the work. That's turnkey investing. You basically buy it. The company builds the house, they put a tenant in it. They manage it for you. When you're ready to sell it, they sell it for you.
Dr. Jim Dahle:
If you want to invest in property out of state, turnkey investment is a great way to do it. And we have a new turnkey partner. This is JAX Wealth Investments. They're associated with a company called Southern Impression Homes. And they basically build homes in a neighborhood in Florida where most of the homes are actually owner-occupied, but then they have these rental homes interspersed among the owner-occupied homes. And you basically can buy one of these homes and they will help manage it for you.
Dr. Jim Dahle:
But if you'd like to learn more about that, we just recorded a webinar with them. You can check it out. It's on the YouTube channel, youtube.com/whitecoatinvestor. You can also just go directly to this link whitecoatinvestor.com/jax to learn more about those investing opportunities.
Dr. Disha Spath:
Cool. All right. Let me mention a five-star review someone left us. And please leave us five-star reviews and tell your friends and family about the podcast. This is from a medical student. He or she says, “Excellent. A worthwhile listen for anyone at any stage of their medical career.” Thank you so much for leaving that review.
Dr. Disha Spath:
Thank you for listening guys. Head up, shoulders back, you've got this, and we can help at the White Coat Investor.
Disclaimer:
The hosts of the White Coat Investor podcast are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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