ChooseFI Episode 517 Summary: "Maximize Your Wealth: Understanding Capital Gains Tax Strategies | With Cody Garrett"
In Episode 517 of the ChooseFI podcast, hosts Jonathan and Brad Barrett delve deep into the intricacies of capital gains tax strategies with their guest, Cody Garrett, a Certified Financial Planner (CFP) from Measure Twice Money. This episode serves as an extensive guide for individuals seeking to optimize their financial independence journey through strategic tax planning.
1. Introduction to Capital Gains Harvesting (00:00 - 06:53)
Brad Barrett opens the episode by revisiting the concept of capital gains harvesting, highlighting its significance within the Financial Independence (FI) community. He references a previously discussed topic from Episode 18R in April 2017, acknowledging that while it was popular, it lacked depth—a gap this episode aims to fill.
Notable Quote:
Brad Barrett [00:00]: "Capital gains harvesting... this is one of our most downloaded episodes of all time."
Cody Garrett emphasizes the importance of understanding income tax to grasp capital gains strategies effectively. He simplifies the taxation system by distinguishing between ordinary income and capital gains, setting the stage for a comprehensive discussion.
2. Differentiating Ordinary Income and Capital Gains (01:40 - 11:22)
Cody breaks down the U.S. tax system into two primary income types:
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Ordinary Income: Includes wages, business income, interest, taxable IRA distributions, and portions of Social Security. Taxed at progressive marginal rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
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Capital Gains: Income from selling capital assets like stocks, bonds, or mutual funds. Long-term capital gains (assets held for over a year) receive preferential tax rates of 0%, 15%, or 20%, depending on the taxpayer's income bracket. Short-term gains are taxed as ordinary income.
Notable Quote:
Cody Garrett [01:48]: "There are two types of income... ordinary income and capital gains."
Brad reinforces that long-term capital gains are beneficial, clarifying misconceptions that they are punitive. He highlights that most taxpayers fall into the 0% or 15% capital gains tax brackets, which are significantly lower than ordinary income tax rates.
Notable Quote:
Brad Barrett [06:53]: "Capital gains, long term capital gains, it is preferential. It's wonderful. You should be doing cartwheels about it."
3. The Allure of Capital Gains Harvesting for the FI Community (11:22 - 28:05)
The discussion pivots to why capital gains harvesting is particularly appealing to those pursuing financial independence. Cody presents a foundational example demonstrating how a retired individual with no ordinary income can realize substantial long-term capital gains taxed at 0%.
Case Study:
- Situation: Married filing jointly, no ordinary income.
- Action: Realizes $123,250 in long-term capital gains.
- Outcome: Entire gain taxed at 0%, effectively creating a "Roth IRA within a taxable brokerage account."
Notable Quote:
Brad Barrett [12:23]: "You've told the government, please tax me on this. But because you're in this preferential rate, you pay nothing."
Cody further explains the progressive nature of capital gains taxation, assuring listeners that even slight overages in realized gains don't severely impact tax liability due to the progressive tax system.
4. Advanced Strategies: Gifting Appreciated Stocks and Charity (32:42 - 39:29)
Cody introduces sophisticated strategies involving gifting appreciated stocks to minimize tax liabilities:
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Gifting to Family Members: By transferring appreciated stocks to an adult child within a lower tax bracket, parents can help their children realize capital gains at a 0% rate, effectively saving on taxes.
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Charitable Donations: Donating appreciated stocks directly to charities or donor-advised funds can eliminate the capital gains tax entirely while providing tax deductions.
Notable Quote:
Cody Garrett [32:42]: "If you have something at a gain, say, can I give this directly to charity or give it to the person if they're at a lower tax rate than I am?"
Brad complements this by explaining the mechanics of carryover basis, ensuring that gifted stocks retain their original purchase price for the recipient, facilitating immediate capital gains realization without additional tax burdens.
5. Case Study: Single Taxpayer in Early Retirement (40:21 - 48:29)
Focusing on a single individual, Cody presents another case study to illustrate capital gains harvesting in early retirement scenarios:
Case Study:
- Profile: Single, age 50, retired with $50,000 annual expenses.
- Challenge: Needs to secure affordable health insurance through the Marketplace.
- Solution: Combines Roth conversions with capital gains harvesting to optimize taxable income.
Strategy:
- Roth Conversion: Converts $14,600 from a traditional IRA to a Roth IRA, aligning with the standard deduction to avoid tax.
- Capital Gains Harvesting: Realizes $47,000 in long-term capital gains, taxed at 0%.
- Outcome: Achieves a gross income of $61,600, resulting in taxable income of $47,000 (all taxed at 0% capital gains rate). Additionally, qualifies for a $3,000 premium tax credit on health insurance.
Notable Quote:
Cody Garrett [40:21]: "All 47,000 of the long term capital gains are taxed at 0%."
Brad highlights the delicate balance between maintaining low taxable income for tax benefits and ensuring sufficient income to qualify for essential subsidies like the premium tax credit.
6. Key Takeaways and Final Advice (48:29 - End)
As the episode concludes, Cody and Brad offer strategic advice for listeners:
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Prioritize Lifestyle: Focus first on ensuring financial strategies support your desired lifestyle before delving into tax optimizations.
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Strategic Planning: Implement capital gains harvesting and Roth conversions as part of a broader financial plan, not as standalone objectives.
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State Taxes Consideration: Be mindful of state-level taxes, as some states may not offer the same preferential rates on capital gains as the federal government.
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Continuous Education: Encourage listeners to review their tax returns and understand their taxable income to identify opportunities for capital gains harvesting.
Notable Quote:
Cody Garrett [48:29]: "Prioritize living your best life. With that said, the implementation of how that happens, that's when you start looking at these opportunities."
Brad emphasizes the critical nature of these strategies, urging listeners not to overlook the "free gift" of preferential capital gains rates.
Final Remarks: Cody and Brad reiterate the importance of subscribing to additional resources, such as Cody's newsletter and the ChooseFI community groups, to stay informed and engaged with ongoing financial strategies.
Conclusion
Episode 517 of ChooseFI offers a comprehensive exploration of capital gains tax strategies, tailored specifically for those on the path to financial independence. Through clear explanations, practical case studies, and actionable advice, Cody Garrett equips listeners with the knowledge to optimize their tax situations effectively. The episode underscores the value of strategic tax planning in reclaiming financial freedom and enhancing overall wealth management.
Resources Mentioned:
- Measure Twice Money: measuretwicemoney.com
- Health Insurance Marketplace: healthcare.gov
- ChooseFI Local Groups: choosefi.com/local
- Financial Independence 101 Course: choosefi.com/fi101
**Listen to the full episode here.