2 Proactive Tax Strategies For When Markets Are Down

There's a lot of advice out there telling people that when markets are down, there's nothing that you can do. You just have to wait for the markets to come back and there's nothing strategic that can be done. Well, today I want to talk about two proactive strategies that you can implement when markets take a dive. But first, let me introduce myself. My name is Warren Berger. I'm the owner of Luminary Financial Advisors, and we help people that are about to retire or just recently retired, create and implement a financial plan that helps save money on taxes throughout their retirement. So the first strategy I want to talk about is called tax loss harvesting, which functions very similarly to how it sounds. And it's the idea that we're going to strategically take a loss on assets that are underperforming in order to offset capital gains that we may have incurred this year.

Or we can take up to $3,000 a year of those losses and apply those moving forward to ordinary income taxes. We're going to take the money from the sale of that underperforming asset and reinvested into a security that is still aligned with your portfolio goals, asset allocation. And so it keeps you invested in the market. So we've, we've strategically taken the loss but we've also reinvested in the market. So we don't miss that on any gains that might be there. Now you might be asking, Well, why wouldn't I just sell the asset and take that capital loss and just buy back the same security and, and start all over again? And the reason we don't do this is there's a rule called the wash sale rule from the irs, and it's designed to protect against people from doing just that. And basically states that you cannot buy back an underlying asset that is substantially identical to the one that you sold if you want to be able to capitalize on this capital loss.

And that purchase can't happen within 30 days before the sale of the security and 30 days afterwards. So there's this kind of 60 day window there. So that's why what we'll do is get another asset that's not substantially identical. It can be similar and will reinvest in that asset, capitalize on that when the markets tend to move higher. Now, if you run a foul of that wash sale rule, really the only consequences that you would not be able to use that capital loss against capital gains or for that ordinary income carrying forward in future years. So you just want to be really careful about how you execute. And just a couple of other things to be aware of when you're looking at tax loss harvesting. The first is that the, the nature of the loss that you're taking is first matched against the nature of the gain, that that is identical.

So if you're taking a short term capital loss, that means on an asset that you have, you've only held onto for less than a year that's going to be matched first against any short-term capital gains that you've had. And that works the same for both long-term capital gains and long-term capital losses. And then once you've matched those up, and just to give an example, if you had a $50,000 capital loss that you were taking this year and you had $20,000 of capital gains, and let's just say they're both long term capital loss, long term capital gains, that $20,000 would match up against the $20,000 capital gain, which would leave you $30,000 of capital losses. Those losses can now be carried forward each year and be used to offset up to $3,000 of ordinary income in each year going forward. So you'd have essentially up to 10 years of that $3,000 a year of, of loss in any given year where you have those capital gains.

Again, you can also offset that money against the capital gains. Another thing to be aware of is that when you do buy that new security, right, you've sold that capital loss, you've bought a new security, you have reset the basis on that security. So basically you've now bought at a lower level. And so when that security does gain in value over time, your capital gains are going to be higher because you have that much more profit that you have on this on this security. So you do want to be aware of when you're going to need that money in the future and some, some of the potential tax implications you may have from the capital gains that you make over time with that security. So you really want to factor in some planning on when it is you'll actually be accessing that money. Another thing that people don't realize is that that capital loss can be applied against most capital gains, and that can include a sale of a house, a sale of a business.

It doesn't necessarily have to be something in the market. The one thing I will say, if you're going to try to execute a tax loss harvesting strategy, make sure you're talking to a financial professional about it. There are a few different rules that are involved here that you want to be aware of. And you could potentially negate that capital loss strategy by executing it in the wrong way. So talk to your accountant or talk to your financial advisor just to make sure that number one, this is appropriate for your own personal situation and also to just make sure that it's being executed correctly as you go through it. If you look in the description section down below, I do have a flow chart that goes through whether tax loss harvesting may be right for you. Hopefully that'll be helpful. So the second strategy I want to talk about is Roth conversions, and we've heard about Roth conversions.

I talk about them on this channel a lot. And just a, a quick review, A Roth conversion is taking money from your tax deferred plans. Maybe it's your 401K or your ira, and you're converting that money into a tax free Roth plan. And you'll be paying the taxes on that conversion now, and the hope is that you're going to be avoiding higher taxes in the future. So that's just the basics of a Roth conversion and there's a number of times and a number of reasons why you would implement Roth conversions. But for our purposes today, we're really talking in the context of markets being down and why would it be advantageous to do this. And the reason is that we're going to be able to convert shares at a tax discount. So let's just take a brief example. Let's just say that you have a hundred thousand dollars sitting in an ira.

Now we know you're going to have to pay taxes on that eventually, but we've decided that we think that your tax rates are going to be higher in the future than they are now. So we are going to try to take advantage of that by converting that tax deferred asset into a tax free Roth. We're going to pay the taxes now because we think that we we're doing that at a discount. Now let's apply that to the when the markets are down. And in this case we're going to say we have this a hundred thousand dollars sitting in an ira, but because of the market decline that is now worth only $60,000, well we can now make that tax conversion over to the Roth and we're only going to be paying income taxes on the $60,000 rather than the $40,000. So we've actually had a discount of taxes based on that ordinary income we would've had to pay on that $40,000 difference.

Now we're going on the assumption that markets are going to behave similarly that they have in the past. There's no guarantee of that, but we are hoping that markets are going to rebound off the bottoms when markets come off. And by putting those assets into the tax-free Roth, not only have we been able to to pay taxes on less of the assets than we would've when the markets were higher, but now when the markets rebound, they're doing it from a tax-free Roth account. So we're never going to have to pay taxes on the new money that comes in. So now if we get back to this a hundred thousand dollars, we've now have the same hundred thousand dollars, but now that's all tax free and we never had to pay taxes on that $40,000 difference. So it can be a real tax advantage to understand that, okay, we are seeing these losses.

There is a lot of stress involved, but we can take certain steps in order to maximize the efficiency of these accounts even when markets are down. Now, there's a couple of things you need to be aware of. One is that there are a number of rules involved with Roth conversions. I have another video if you look below that talks about Roth conversions and gets a little bit more deeply into those rules. You also want to be aware that it is more advantageous to do the Roth conversion if you have cash on hand to pay the taxes rather than having to pay from the tax deferred account. You'd prefer to have either cash to pay taxes or something coming from maybe a taxable brokerage account in order to pay that increased tax on the conversion. And then you want to be aware of you know, when you take that conversion, you're increasing your ordinary income and so it may move you into another tax bracket. And by jumping into that next tax bracket, you're going to want to be aware of the impact that may have on such things as Medicare, social security, or even some tax write-offs like the child tax credit. So once again, you want to talk to your financial advisor,

Your cpa, or really just do your due diligence to make sure that this is an appropriate strategy for your personal situation and that it's being executed correctly. I have also included a flow chart below that asked the question, should I consider doing Roth conversion? I think that's something that might be helpful to help you figure out whether or not this strategy may be right for you as well. I hope this video has been helpful for you. In addition to the flow charts I mentioned earlier, I also have a number of flow charts and checklists for people that are approaching retirement that I think are helpful in making decisions. I've included a link to my personal calendar. If you'd like to schedule a complimentary call to talk about your own personal financial situation, I'd be happy to talk to you. Thanks for watching. I hope to see you.