Sometimes people get so caught up in their retirement investments and savings that they forget how to properly manage their non-retirement related investments. This episode is our way of stopping you from making this mistake. Spend time with Zacc Call and Laura Hadley as they are joined by Tyler Williamson, Partner & Wealth Advisor at Capita to talk about how your non-retirement investments are taxed, how to limit taxes on capital gains, and so much more! Together they discuss: What you can expect to learn in their upcoming seasons of the Guided Path, important time frames you should be aware of when investing, the different types of non-retirement investments and their taxation, and more.
[00:00:00] Welcome to The Financial Call. We are financial advisors on a mission to guide you through the financial planning everyone should have, whether you're doing it yourself or working with a financial advisor. These episodes will help you break down complicated financial topics into practical, actionable steps. Our mission is to guide motivated people to become financially successful.
Zacc: Welcome to The Financial Call. We're excited to have you back. This is weird. This is one of my favorites. Probably my favorite season. It's the one no one likes. And that's what makes us strange apparently. But I love taxes because you know, with investments sometimes it's really frustrating because so many external factors impact investments. And you may have just this perfectly thought out thesis and it doesn't play out how you wanted it to, but with taxes, I feel like we can really add more value to a client and be pretty sure that we're adding value to them. Sometimes it's fun to see, oh, we saved that person $10,000 this year, or $5,000 this year by
[00:01:00] one or two specific strategies. So I think that's what makes it so exciting for me is because as we learn more about it, it feels like you can help people and be pretty confident that you're actually doing a whole lot better. I don't mean to downplay investments in other topics, but there are just so many other variables out there that make it more complex.
Laura: Yeah. You actually know what's gonna happen with taxes. At least for that year.
Zacc: Yeah, for the short term, right? Yeah. Which is nice. So let's give you a little recap. This is the fourth season, and if you're following along with us, thank you. This is a big project. We're getting close to halfway done with Wow. Easy. The entire guided path. Weird, right? Yeah. We're getting there. So the fourth season is halfway through. This is tax planning. What's coming next in future seasons? Estate planning is five. Business owners is six. Charitable giving is seven, and insurance is eight. And within this season of tax planning, we have already looked at how the government calculates your taxes and Roth versus traditional. Those were episodes one and two. And then episode
[00:02:00] three within season four is how are non-retirement investments taxed? I think this is one of the most confusing ones because an IRA is simple, right? Money goes in, comes out, and it's either taxed at the front end or the back end. Depending on Roth or traditional 401ks are very similar. But if you buy a rental property, how does that affect your taxes on an ongoing basis and later when you sell it, if you just buy some stocks and bonds in a regular investment portfolio, how does that change it? I think this really is complicated for a lot of people, and I'm surprised to find out how many people don't know. That you can just open up a brokerage account and buy investments. I was the same way when I first started. I thought you could only do it in IRAs and 401ks. And then if you're lucky enough to max out an IRA or a 401k, a lot of people just stop saving. They're like, well, I did it. I did the max I can't do anymore. And the most wealthy people we see actually have a lot more money in non-retirement investments than they do in
[00:03:00] retirement investments because retirement investments are typically capped on contribution limits. You could put a million dollars into a non-retirement account in a day, and it doesn't matter. Government doesn't care. Now, the reason they don't care is because you'll be paying taxes as you go. So we're gonna cover all of that. Anything else to add? Oh, by the way, we have Tyler back. Sorry. So Tyler Williamson. He's our resident expert in so many areas. Social security's one of them. So if you were along for the ride in the first season and the second season, we had Tyler in both of those to help us talk about social security. And then I feel like you've also really spent a lot of time. On non-retirement investments. And so we wanted Tyler back for this.
Tyler: So you've had me as a guest twice. Oh, only twice. Sorry, three times, but twice on social security taxes. You've invited me back for the, probably the two most hated topics, . Yeah. When it comes to financial planning, social security. And taxes because you make it that much better, Tyler? I hope so. Yeah. Oh, how sweet. That was nice. Laura
Zacc: Tyler is wearing a puffy
[00:04:00] coat because it's so cold, and we were trying to figure out if it would be audible in the microphone. So far we're doing pretty good. I now, Laura, offered a blanket. I feel like that was a little, you know, a little too much. So . All right, we're gonna dive into this again. As always, if you have questions, we're on most of the major social media platforms, or you can contact us directly. Go to the financialcall.com. That's the website. Let's dive in. So non-retirement investments. Are taxed as you go, as you make money, and there are some pros and cons to this. Let's just try to jump into some of the basics. If you hold an investment for longer than one year, and I'm going to be simplifying this because there are exceptions, but with anything. If we get too far into the weeds with all the exceptions we won't get, the main thing you need to know is one year is the time period that's important for most investments. After a year, it's long term and under a year, it's short term. The government is incentivizing you to hold investments for longer than a year if you hold them
[00:05:00] for longer than a year. There's actually a chance in certain tax brackets that you have to pay nothing in federal taxes. That's a surprise to a lot of people, especially retirees as they transition into retirement, oftentimes their income drops enough that we can purposefully sneak long-term capital gains out at a 0% tax bracket.
Laura: And just to clarify with the gains that we're talking about, this is the growth that you're having inside of your account. So when you put money in, you've already paid taxes on that money into a brokerage account, so you don't pay taxes on that money again, you're not being double taxed, but any growth that you have on top of that, that does become taxable. So when we're talking about gains short-term or long-term, it's that growth that we're talking about.
Zacc: Yeah, good point. And you don't pay it until you sell, and that's something else that can be really efficient. If you're patient and you just hold onto investments for a really long time, you don't actually have to pay any taxes on that growth yet.
Laura: Yeah, it allows you to control the taxes, but it's also something to be aware of.
[00:06:00] If you wanna get out of an investment, buy something different, you have to be aware that that is gonna kick off some tactical gains.
Tyler: And I think it's more to, to realize as well that this isn't just like stocks and bonds. But you mentioned earlier real estate as well. So even within real estate, if you're gonna buy a rental property, it's important that you wanna hold that for, you know, at least a year or more so that you the long-term capital gains rate.
Zacc: Right. There was one time, I'll have to tell you a quick story. There was one time I wanted to change some investments within my portfolio and I was about four months away from hitting the long-term time period. And this is one of those that, like I had this idea, I thought it was a good idea. I wanted to change the risk profile in the portfolio a little bit. I felt like markets were going to be positive, like the typical financial advisor. I'm typically happy thinking markets are going to go up over time, right? So I wanted to sell certain investments and buy others that I thought would benefit more from that positive market. But it was four months away from that. I didn't make the change because I was so handcuffed by the possibility of paying short-term
[00:07:00] capital gains, and the difference in performance between those two investments was so wide that it would have been so much better to pay the short-term capital gains by the investments I believed in and wanted and just ride those up. But hindsight's 2020, it could have obviously gone the other way. But the point is, we've talked about this before, there's never a wrong time to be in the right investments. So be careful of letting tax, they say don't let the tax tail wag the dog. Be careful of placing too much of your decision making in taxes. Okay, so long-term capital gains are fantastic because they're typically about 10% less. We talked about the 0% bracket, so most people are taxed at 15% on long-term capital gains. And then, We were looking up numbers before, maybe Tyler, you have them in front of you, but where does it, and then it goes up to 20%. At what line does someone move from paying capital gains of 15% to 20?
Tyler: Okay, so if you're a single filer, if you are below
[00:08:00] $492,300, you are in the 15% capital gains tax rate or tax bracket. Anything above that 492,300 above is gonna be 20%. Okay. And then for a couple, it's a little over 550,000. Yep. 553,850.
Zacc: So that's a lot of income you can experience without having to worry about that extra 5% tax on your capital gains. So again, that's, most people are at 15%. Some lower income folks are at zero. And then really, really high income people at 20,
Laura: So we talked about this last time, but a lot of people in that 15% tax bracket for long-term capital gains are actually in the 22 and 24% tax bracket for ordinary income. And so that's where you can see the difference. If we can get that long-term capital gains rate, but 15% versus a 22% on their ordinary. and you save 7%, or like you were saying, close to 10% before the tax brackets changed.
Zacc: Right? And that's also confusing because here are the long-term capital gain rates and so many people want to know, well, what are the short-term capital gain rates? They are just your regular income rates. There's not an entirely different bracket for those. It's just, it just pours over as regular income.
Laura: So short-term capital gains tax to your ordinary income tax rates, long-term capital gains, you've held it longer than a year than you're taxed at these rates of zero, 15 or 20%.
Zacc: So we're gonna go through several different types of investments and how that changes it a little bit. We're gonna talk about some of the opportunities and strategy. There's something you should be aware of before that 20% tax bracket. Not a lot of people realize that there is a Medicare surtax of 3.8% and that Surtax kicks in way before the $492,000 number for single people and $553,000 for joint couples. The way that works, it's, we're not gonna go into a ton of detail, but
[00:10:00] be aware for a couple, for example, If you have income over $250,000, any investment income, which, so basically the way I look at it is take all your income and pile it together. Let's say someone had a hundred thousand dollars of regular earned income and then they had $300,000 of investment income. And always think about these different sources of income as Like liquid, like oil and water. There's heavier and there's lighter. Okay? Your regular, your high taxed income is the heavier liquid, so it drops to the bottom of the vase or cup or whatever you've got imagining here, and then you put a lighter liquid on top. That's your capital gains and investment income. So as you, as you drop that regular income, that hundred thousand to the bottom of the cup, and then you pour on another $300,000. Just the portion of investment income above $250,000 experiences the extra 3.8% tax. So it's actually 18.8 for those folks. For that last what would be
[00:11:00] $150,000. $150,000? Yeah. Now, if somebody had $300,000 of earned income and no investment income, they do not pay the Surtax because there's no investment income on which to pay it. But if they. $10,000 of dividends or interest, they would have to pay it on that $10,000 because they're already over the two 50 mark.
Tyler: So the net investment income tax applies to any interest earned, dividends, capital gains, I believe even rental income, real estate income.
Zacc: Yeah. I'd have to look at them, I believe as a passive. As passive, yeah. Mm-hmm. . So it could be anything that you can think of like where you are a passive investor and receiving some sort of interest or payment or income capital gains from a sale of an investment, anything like that.
Tyler: Okay, so for that example, you just used that individual earning 400,000, a hundred thousand of just regular taxable income, $300,000 of capital gains or dividends or whatever it may be. The the amount over the 250, which is the net investment income line, the
[00:12:00] threshold, the amount over 250, which is 150,000, would be taxed at an additional 3.8%. Correct. And then we talked about the 20% bracket, right? Which comes in at anyone. If you're married and filing jointly and you're making over 553,000, well then you're gonna jump up to 20% and then you add the 3.8% on top of that. So now you're 23.8%. If you've got a lot of investment income that surpasses that 550,000, you got it. You got it. Yeah. So when people sell a business for millions of dollars, typically the number that they'll have to pay, we see this often when someone is exiting a business that they've built for 20 or 30 years and they're selling it for five to $10 million or something like that. That sounds crazy. We do run into this pretty regularly, but just be aware, those folks are all looking at 23.8. Federal Tax Plus here in Utah, it's about a 5% tax, so we just assume they're going to pay about 28.8% away and any little thing that we can do to reduce their tax bill when they sell that business, which we'll talk a lot
[00:13:00] about in later seasons, business owners and charitable giving and things like that. But anything, if you can reduce that gain by a hundred thousand, you just saved them $28,800 because it's 28.8% tax. So, yeah. That's great.
Zacc: Okay, so let's talk about the different types of investment. There's interest, dividends, interest is generally like a bond, paying you some sort of payment bond. We've talked about that in the past in previous episodes, where you've lent money to someone else, another entity, and they agree to pay you some sort of interest or some sort of payment regularly. That's typically tax debt, ordinary income rates, and that's also considered investment. Then dividends are also considered ordinary income and investment income, but they can be taxed at long-term capital gains rates. That is if they are qualified, so, The best part is the definition. If you look up like the definition for qualified dividends, one of the rules is the government
[00:14:00] has to say that it's not not qualified. You know what I mean? Or anyway, so it's funny the way that they word it, but the bottom line is it needs to be a US company or a qualifying foreign entity, and It needs to not be purposefully excluded by the IRS, basically. And then there's a holding period, which has to do with 60 days throughout 128 period. We're not gonna go into all of that, but the bottom line is if it's qualified, you get to throw it on as long-term capital gains, which is so great. You know, if we have clients with pretty sizable portfolios that are getting 50 to a hundred thousand dollars of dividends, if they can have more of that go over as qualified versus non qualified. Then that could save them. To your point earlier, Laura, like maybe up to 10% difference between ordinary income rates and long-term capital gain rates.
Laura: Yeah, and I think it's important to remember that these things will happen even if you're not buying or selling inside of your account. So maybe you didn't sell anything, so you didn't kick off any capital gains. but you still get a 1099 for your brokerage account because you had interest in dividends inside of the account. So just
[00:15:00] be aware of that. You know, you maybe didn't have any sales inside of your account, but you still likely will owe some taxes because of the interest in dividend.
Zacc: Right, right. I know a couple of investors who have big non-qualified accounts but don't have a lot of income and they have to take withdrawals to pay for the tax bill. You know, because if they show a couple hundred thousand dollars of. Inside their account, but they're not withdrawing anything. Then I'm thinking of one person in particular, and if she's not withdrawing anything, she doesn't even have enough money on her regular income to pay the tax bill. I mean, obviously she probably should be spending a little bit more of her money, but that's a tricky part. It feels like phantom income, like you don't, you don't actually get to see it, but you have to pay taxes on it. Yeah, it's a little bit frustrating.
Tyler: One thing I was gonna mention on that interest topic is, A big thing today that we're seeing a lot of clients doing is they're buying CDs because the rates for CDs have come up substantially, right? Or these high interest yield savings accounts, those are now paying three, four, up to
[00:16:00] 5%, and you will get a 1099 from that bank or that credit union or whatever institution you're working with that is providing you that account. You're gonna get a 1099, and that is going to be taxable to you now, but that's not gonna be favorable from a tax. Because you're, you'll just pay your ordinary income tax rates on those interest payments, whereas with qualified dividends, you'll receive that more favorable tax rate.
Zacc: Right. Let's talk about some of those, like your experience as an investor. So you've invested all year long. You brought this up. That's what made me think of it, Laura. That. as an investor all year long you've owned these investments, especially if you have somebody else managing the portfolio for you. You don't know what's been sold. You don't know how much trading has gone on, you don't know how much you have in dividends or interest. And then February, March rolls around and you get this 1099. And nowadays they do what's called a consolidated 1099, and each section on the page has a different letter. And so the 1099 Div, DIV shows your ordinary and your qualified dividend.
[00:17:00] and then there's a 1099 B as in Bravo or as brokerage transactions that shows all of your sales and your capital gains. And so I think it's wise if possible, if you have a non-retirement investment account to check in with your account or your financial advisor in October, November, December. And find out how much have we experienced, how much was it last year? Have you changed your portfolio very much compared to last year? Can I expect about this same amount of dividends and interest? Just so you don't have a huge surprise when March rolls around and you have this big tax bill that you don't, don't expect.
Tyler: Because there's, to your point, there's some things that potentially you could do ahead of time, right? And maybe I'm jumping the gun here, but tax loss harvesting is probably something you'll talk about in the future that an investor could proactively do. To show losses to offset some of the gain.
Zacc: Yeah, that's in this episode. Let's just do it right now. So, Tyler, explain that. What do you mean by that? Let's say someone has done their work, they've looked at their account, or they've talked to their financial advisor.
[00:18:00] They see that they have a $20,000 gain. That has been realized because the financial advisor or themselves, they decided to sell something that had done well. It just was time to, to rebalance or do something. So they have $20,000 logged as a gain and they're going to have a pretty decent tax bill. What can you do to fix it? Tax loss harvest. Oh good. We're done. , that. That sums it up. Explain Tyler.
Tyler: Yeah, that sums it up, but what does that mean? So yeah, I'm just teasing. I think when the markets are down 2022 was a great example of this. The markets are just, they're having a really rough time. And as investors we're sitting there thinking, gosh, everything's bad. But there's actually some really awesome opportunities that as an investor you can proactively do to help offset that gain. It's called tax loss harvesting, where you go in and you identify positions that are at a loss and you sell them on purpose to offset the gain inside of your account. And that doesn't mean that we never wanna get back into those positions. Right. Those are
[00:19:00] positions that we like. But if we can strategically sell them on purpose to harvest the loss and offset the gain and then get back into them within 30 days, after 30 days, then that will help offset that 20,000 or up to $20,000 of gain. And if you think about that from a tax standpoint, an individual or investor can eliminate $20,000 of capital gains and they're in the 15 or 20% capital gains tax rate. That's quite the savings for the individual.
Zacc: Right? Several thousand. I mean, they're saving three to $4,000, depending on their tax rate there, for sure. Okay, so that's really good. Let's talk a little bit about insurance, and we're gonna talk about how annuities and insurance is taxed. We're gonna talk about real estate and depreciation and income. And we'll talk a little bit about businesses we have in the business owner section, for example. We're gonna cover that in episode one of season six. We'll talk more about tax loss harvesting in more detail around retiree strategies for taxes. But today it's mainly gonna be,
[00:20:00] now we're gonna talk about insurance and real estate and then wrap up and give you just a general understanding of all of this. So, insurance, annuities. This is really, I'm just gonna throw this out there. I actually don't love That annuities are pitched as a tax deferral benefit, because in my mind, if you can manage non-retirement accounts well, the tax benefits of a non-retirement account, the control of tax loss harvesting, donating investments, if you're a charitable giver, just managing qualified dividends versus regular, I think you can manage a non-retirement account better and at lower rates, more favorable rates. Right? Long-term capital gain. When you buy an annuity, let's say you put a hundred thousand dollars into an annuity, and by the way, we have plenty of investors that work with us, that we've helped them buy annuities because I think that they work really well. And in fact right now, rates have come back in a way that they've become even more attractive. For a long period of time, we didn't do them as much, but anyway, give you an idea. I'm not against them. I think
[00:21:00] they can be a very valuable tool. What I'm trying to say is if you're thinking the reason to buy one is because of the tax benefits, I'm definitely not sold. I think that it's not as helpful because the money you put in put in a hundred thousand dollars, let's say it grows to $150,000 as you take withdrawals. Let's say you're taking a $10,000 withdrawal per year. You're carving that off of the top. It's called Last in First Out Lipo. So the last in is the growth. The first in was your own contribu. So if it's coming out lipo last in, first out, you're scraping off that cream across the top and paying ordinary income rates. It's always taxed at ordinary income rates. Even if you've held the investment for over a year, it doesn't change it into long-term capital gain rates.
Laura: And you might still be working when you take out the first withdrawals, and so you're at a higher tax bracket and you have to. That higher tax rate on these funds, whereas if it was in a brokerage account, you might have more control of it.
[00:22:00] if you buy an annuity with a retirement account, this is a totally different story, right? Because none of that has been taxed, so it doesn't really matter. So it's really weird. A lot of insurance companies like you to be discussing the tax benefits of taking non-retirement of money and putting it into an annuity. I would almost prefer putting more IRA money into the annuities because those are going to be taxed as ordinary income no matter what. We don't ever have a chance at long-term capital gains withdrawing from an ira, but we do have a chance at long-term capital gains with a non-retirement. So it's a little bit like using the right asset in the right place. They call that asset location. I just prefer using IRAs more for that. Now there are some annuities depending on the type, and this needs to be a longer discussion at the tail end in our insurance season, where we really break down these different annuity types and explain how they work. But some annuity types have what's called an exclusion ratio. So if you have one where you're thinking, well, how do I think it's actually pretty tax
[00:23:00] efficient? There are some that are more tax. And the way that those work is, let's say you put in a hundred thousand dollars, they figure how much of it, the income that you get off of it is growth versus how much is your own principle coming back. And sometimes you might be able to say like, okay, we're getting $600 a month off of that. $400 of it is my own principle coming back and 200 is growth. And so you only have to pay taxes on the two. Typically the ones that allow for an exclusion ratio are extremely rigid, meaning you don't have as much flexibility. You can't just withdraw as needed whenever you want. They typically lock you into a payment for the rest of your life, which isn't bad because oftentimes it guarantees for the rest of your life anyway. Once again, it's a rabbit hole we will go into, but understand the tax side is what we're talking about today. I typically prefer IRA money for annuities if we're thinking that way. What do you, am I off the rocker here, Tyler?
Tyler: Nope. I completely agree. And. So one of the consequences you just mentioned of not being able to take the income at capital gain
[00:24:00] rates versus having to take it all as income rates. I think that's one of the greatest consequences. But on that same token, I think even worse maybe, is the fact that annuities don't receive a step up in basis. , right? And so let's say you have, you know, a hundred thousand dollars annuity non-qualified, so this is not owned by a retirement account by an IRA, but a non-qualified annuity. And that annuity during your lifetime turns or grows from a hundred thousand up to 150,000, and then you pass away, your children or whoever inherits that money, whoever your beneficiary is, will have to pay tax at income rates on that $50,000 gain when they withdraw those funds. Now, let's compare that to the brokerage account, right? Let's say you have a hundred thousand dollars brokerage account. You're buying stocks or mutual funds or index funds, or whatever it may be, and that same a hundred thousand dollars turns into 150 when you pass away, your beneficiary will receive that 150. With a step up in basis, meaning they will not owe tax
[00:25:00] thousand dollars. King, this might be something helpful to point out.
Laura: I'm sure people have heard the term cost basis. That's the amount that you put in after tax dollars. So that's kind of the watermark that they're measuring your growth from. So when they say You get us. Step up on the basis. That amount goes up to the actual value of the investment, the brokerage account, or real estate at the time of death. That's the new cost basis. So now there's no more growth to pay taxes on. So when you hear the term cost basis, that's the principle that you put in. You already paid taxes on it.
Zacc: Yeah, for sure. Okay, let's just throw this out there. We are isolating one issue right now, right? Tax. That's the only thing we're really talking about, and I want everyone to understand that this is one of the most difficult parts about financial planning is that there are many risks, not just one. And if we looked at just tax, it would lead you in one direction. If we looked at just safety, it would lead you in another direction. If we looked at just the highest growth, It would leave you in another. Anyway, you get the idea. The most
[00:26:00] flexibility takes you in one path. So these are all factors that impact your. , and that's part of the conversation with someone is to determine how much do you care about flexibility? How much do you care about guaranteed income? How much do you care about high growth? And, and as you understand an individual, you can as an advisor, weigh those different categories more. But once again, we're trying to be, we're really trying to isolate tax on this for you. And so, Don't get us wrong here and think that one is better than the other in any of these types of investments. I'm trying to help you understand the tax consequences, and this is a podcast to keep it short. So in that theory, let's keep going. We have real estate to talk about. This is confusing to a lot of people because sometimes people will talk about real estate being a huge tax benefit, which I think it is. And yet they'll have positive cash flow at the same time. So you can somehow show a loss on their taxes while you have positive cash flow. I'm gonna explain how this works very generally, and then maybe Laura, Tyler, you guys add whatever you want to it and, and we see how deep we
[00:27:00] go. But the concept is that when you have a rental property, like I had a rental property in North Salt Lake, it's just north of the downtown area of Salt Lake City. Had it for about 10 years. And it was worth about $165,000 when I bought it. And we rented that out for $1,100 a month. Had an HOA as well, cost us about 200 and change. It. Paid some utilities anyway. We were slightly cash flow negative on it when I considered my mortgage. So in my mind I'm like, This thing, man, it's just barely treading water. But if you set aside the mortgage, the IRS doesn't care how you finance a property. They considered us cash flow positive because we got 1,100 in rent. Had to pay the HOA out of that, which is about 200, a little bit of utilities, another hundred. So they're looking at us like, well, you're making about $800 a month. But there's this thing called depreciation. The idea is that the structure, someday, somebody's gonna take a bulldozer to that thing
[00:28:00] Just tear it down and rather than having to wait for 30 years until that day to finally get to claim that loss on my taxes, the IRS allows you to take a little piece of that loss every year as you go. That's depreciation. Now, the land itself. Doesn't lose value. So you don't get to depreciate the land, you get to depreciate the man-made portion of it, the structure of the building. So we were able to depreciate, even though I showed a gain of $800 a month, we were able to depreciate more than that. So while we had positive cash flow, we were able to show a loss on our taxes, and that was helpful. So that. Basically think of it like its own little business. They add up all the income, they add up all the expenses, they net the number out, and then it's a negative number. And then they carried that over to my personal tax return and applied that negative number to my personal tax return. So it reduced my wages basically, and I didn't have to pay as much in tax because of that. So that was great.
[00:29:00] Fast forward a decade and we sold the property in 2019. All that depreciation the government is saying, hey We let you take this loss each year thinking that when the bulldozer came, the property would be worth nothing. But lo and behold, you sold it for $230,000, even though you bought it for 165, which by the way, for a decade, we did not buy in a great area. That's just not great growth if you're thinking about a decade in real estate. Right? It was our first home that we bought and we ended up having twins unexpectedly, and we already had a kid and we just ran outta space. This was in the recession, so we couldn't sell the thing for, they were selling them getting off subject here, but $90,000 is how much they were selling for at the bottom of 2008. And my wife and I just looked at each other and said, looks like we'll be holding onto this thing for a long time. So it went down to 90, came back up in 2019 to about two 30 and we sold it. So when we sold it, basically the IRS. Hey, you
[00:30:00] didn't lose this edifice, the building, you didn't get bulldozed eventually, so you have to recapture that depreciation. And the recapture rate is 25%. And then on top of the recapture, we had capital gains right from 165 up. , we had capital gains so that I had to report on my taxes that year on top of my other income. And that's where we're talking about the thing you were talking about earlier, Tyler, where at what capital gain rate are you? Are you subject to net investment income tax? How does that work? One other thing about real estate, if it's your own residence, you can exclude up to $250,000 of gain per person in a couple up to two people, right? So you could do, like if you have a couple and you're selling a property and you have a $700,000 gain on it , then you'd only have to pay capital gains tax on 200,000. Get rid of the 500. That comes as a huge surprise to people. Not the fact that they can reduce it, but the fact that they have to pay taxes at all. I find so many of our clients, when we tell them, then
[00:31:00] they say they're selling a property for a million or a million and a half dollars, cause home prices have just skyrocketed. Right? And we say, hold on, wait a second. How much did you pay? Oh, $200,000. Many, many years ago. They say, wait a sec, you really need to set some money aside for taxes. This is gonna be, this is gonna be painful. Especially with the run up in real estate we just recently had. Right, right. Hey, and just for clarity, so that the listeners may not be confused, you moved out of that condo and bought a different home, right? Yes. And so it was not a primary residence for you at the time that you sold it. Yeah. And that's why, yeah, that's a good point. So we lived in it. Three years, I believe, and then about three or four years, and then we moved out of it, bought another home. That was a little bit, which was scary at that time. It was so scary to have two mortgages and not know if you were gonna have renters and then the renters would trash it and not know how much you were gonna have an expense to just get it for the next renter. Anyway, it's a scary time for sure. But yeah, we lived in the next house for seven years. And rented the first house at the same time and then eventually sold
Laura: So to qualify as a personal residence, you have to have lived there two of the last five years, right?
Tyler: Correct. So your conduct, you weren't able to avoid the recapture plus the capital gains tax, but when you sold your second home and moved into your third home because it was a primary residence, you were able to avoid all of that?
Zacc: Exactly. Yeah. And, actually, all that timing coincided. We used the gains from the rental property and the gains from our current home to help put down for where we live today. The third home I guess. But yeah, that all coincided. But you're right, Laura, to your point, we lived in it for two of the last five years on the actual home, the second home in Farmington where we, where we live, we were able to exclude all the gains cuz we didn't make more than $500,000 dollars there. And then had to recapture and pay capital gains on the rental property, which was when we were about three years out that I thought if we could just sell it now, then we wouldn't have to pay. Cause you know, we would've lived in it for two of the last five years on the first rental
[00:33:00] property. But, . The prices weren't there three years after we moved out. It wasn't even close. Hadn't recovered. Yeah. Just hadn't recovered. Did you ever think of moving back into the condo? I thought about it. I thought I talked to my wife about it and it was a definite no. It was hard, no, it was hard, no there There was no room. When we showed that property, all my daughter's toys were out in the living room because that's all the space we had. So when we showed the property to sell, we had great neighbors at the time. We would gather all of her like high chairs and seats and toys and everything and run 'em across the street and dump 'em in our neighbor's front living room while we showed the house. And then afterwards we'd haul it back up. My wife got so sick of it that there's absolutely no way, Tyler, you know my wife? I do. She's amazing, but. That there's a line. Don't blame her. Yeah. When Michelle says no, it means no . Yeah. All right. I think we did it. Businesses, we have a lot to talk about later. I would say the main thing to talk about with businesses is the difference between S Corps and LLCs. I'm just gonna tease this a little bit to you, and then we'll have to do it another day as we're running a little
[00:34:00] bit long today. Everybody gets really confused about this. LLCs are probably the most common business set up for new business. You can make what's called an S Corp election and it allows you to separate your income and say, I only am going to pay F tax, which is self-employment tax, which is about 15% tax on top of all the regular rates on a portion. You can separate it and say, this is my wage, I'm paying FICA tax here. The rest I'm just taking as a business owner's draw. We'll cover that in more detail, but that can save people thousands and thousands of dollars if you understand the differences. LLCs and S-Corp at that time will also talk about partnerships and C-Corp and how that works. Anything else to add before we wrap up?
Tyler: I think that's great.
Zacc: Thank you, Tyler.
Tyler: Thanks for having me.
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