[00:00:00] Speaker A: In this episode, we talk about a tax and investment concept that's been all over the news recently called Unrealized Gangs. Let's get started.
[00:00:08] Speaker B: Let's get some money from new money new problems. It's the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
Negotiating compensation. Purchasing your first investment property. Helping your family with money. The highs and lows of entrepreneurship. New money brings new problems that require new solutions. Join us as we work through them together.
I'm Brenton Harrison, and this is the New Money New Problems podcast.
[00:00:46] Speaker A: Hello. My name is Brenton Harrison of New Money new problems and your host for the new Money New Problems podcast. If you're listening to this on Friday, September 6 and you're used to seeing our episodes pop up at 05:00 a.m. m Central Standard time, you will notice that this episode is posted a little later. I ask you to bear with me. I told you when I started this podcast, we would do two years in a row of new episodes, no replays. But unfortunately, this week, uh, I have been traveling and had some problems with the original recording of this episode. So I'm actually having to re record it today on Friday, September 6. But the standard is the standard. So you have your new episode for today, but my apologies for posting it later than you might be used to. We've had some cool things that have been going on at new money new problems, and one of them next week is, believe it or not, our posting of, uh, the 100th episode of the New Money New Problems podcast. And it has been a really fun ride. And I have a favor that I want to ask you as our community leading up to next week's episode, we're going to put this on our socials as well. But for next week's 100th episode, what I plan to do is to list my biggest financial mistakes that I have made since I started working in financial services. And I'm not only going to list each of those mistakes and. And how they impacted me and unfortunately, my wife. I'm also going to try to actually put a dollar figure to exactly how much we lost or how much it cost us. So you can see that not only do I struggle with many of the things that we've talked about on this podcast, uh, but you learn from certain things through experience. And if you take the right things from that experience, it can be very informative to make sure that you make more money in the future. So some of the things that I've done in the past that were wrong, they led to me doing right things on a bigger and better stage down the line. But what I would like for you to do is if you are willing, either on our socials or you can send an email to infooneynewproblems.com. we want you to share what you feel are your biggest financial mistakes as well. If they are going to be on the podcast, we would make sure that we de identify them and send you back what we plan to share for your approval before posting. But we want to make sure that our community is growing and learning, even by mistakes together. Because, uh, I have seen many times people get very frustrated and down on themselves financially because they feel like they are the only ones going through a certain experience and very, very rarely is that the case. So if you're willing, send what you feel are your biggest financial mistakes to
[email protected] or when you see us post on our socials, feel free to share there as well. Now let's get to this week's episode. In this week's episode, we are talking about a concept called unrealized gangs. If you've been following the political news, this is a topic that has been, uh, talked about a lot, and I see a lot of people complaining about it without even really understanding what an unrealized gang may be. And this is not a political podcast, so we're not going to talk about specific political proposals on this episode. But I do want to talk about the concept of unrealized gangs, what they mean, how they impact you, and also bring a term back from our tax episodes called cost basis that I think will be instructive as you start to grasp the concept of unrealized gangs. So what is an unrealized gang? Well, to put it simply, an unrealized gang is a tax term, and it occurs when you have an investment that you purchased or contributed to that has grown in value. So, for example, you bought something for $10. It's grown to dollar 15, but you have not paid taxes on that growth. The term realized just means that you've paid taxes on the growth, whereas an unrealized gang means that it has grown in value, but that value growth has not yet been taxed. That's all it means. And when it comes to gangs and how you realize them, or how you pay taxes on certain investments, it's important to bring back to your attention the difference between what we call qualified investments and non qualified investments. A qualified investment is something like your ira, your 401k, your 403 b. And the difference between a qualified investment and a non qualified investment is with qualified investments, the growth on your investments is deferred and you don't pay taxes while they grow. You instead pay your taxes either when you contribute the money or when the money is withdrawn. So, for example, with a pre tax 401k, you're putting in dollars that you have not paid income taxes on as of yet. The growth of those dollars is not taxed. But when you take those funds out in retirement, you pay taxes on the money as if you earned them. They are subject to ordinary income income taxes. Those are qualified investments. And the concept of unrealized gains aren't as big of a deal with the qualified investment because of those deferred taxes. It's either ordinary income tax on the front end or on the back end. A, uh, non qualified investment is one where your cost basis and the concept of an unrealized gang has more import because a non qualified investment is subject to capital gains tax. Capital gains taxes are the taxes that you pay when you realize growth in a non qualified investment. So an example of a non qualified investment would be the home in which you may live. If you sell that home for more than you purchased it, then you could have a realized taxable gain in some instances, if you have an investment property. The same may be true if you have a brokerage account in which you hold certain mutual funds or exchange traded funds or stocks. All of those different investments in non qualified accounts are subject to capital gains tax. You put money in, it grows beyond the value that you contributed, and there is a point in time if they are sold or donated or transferred to someone else, where that gain may be realized for tax purposes. And as with most taxes that you pay in our economy, the amount that you pay in that capital gains tax is dependent, heavily dependent on how much taxable income you have for either yourself or you and your spouse, and even whether you choose to file jointly or married, filing separately. If you're looking on screen, you're looking at a tax table that we'll share in the show notes that shows the tax rates for capital gains in the tax year 2024 for those who will be paying their or filing their taxes, I should say in 2025. And you can see that for a single person, as an example, for their taxable income below $47,000 and some change, they actually would pay 0% in capital gains tax for a single person who has taxable income ranging from 47,000 up to 518,000 it's 15%. And for a single individual who has taxable income of $518,000 or more, they would pay 20% in that same tax rate mix. So you can see, based on these tables, that I would say the majority of people in this country, unless you are an ultra high income earner, are going to be paying 15% in federal capital gains. But you also will have capital gains at the state level, depending on which you live. Looking at another article, which we also will share in the show notes, you can see that there are a number of states that don't tax capital gangs. As a matter of fact, those states are Alaska, Florida, New Hampshire, Nevada, South Dakota, Texas, Wyoming, and thankfully Tennessee, where I live. But there are also states that tax significantly when it comes to their highest rate for capital gangs. As a matter of fact, California and I, New Jersey, have tax rates of 13.3% and 10.75%, respectively. So you could owe a significant amount in these gangs if they are realized. And this is why the planning that you do to avoid paying capital gains tax is really crucial when you have non qualified investments. And that's where the tax term cost basis comes into play. Cost basis is another term that's really only relevant from a tax perspective, and it refers to the original value in terms of what the owner has of an asset. And that value is adjusted up or down based on certain factors. And the IR's uses your cost basis to determine whenever you sell that asset, the amount of gain that you received from a taxable perspective, or the amount of loss that you experience from a taxable perspective. So going back to our example, if we have something where our cost basis in an investment is $10 and it grows to $15 before we sell it, then selling for 15 with a cost basis of $10 means a realization of a $5 gain. If there was something that occurred where even though we bought it for $10, our basis was adjusted down to, say, $7, then we sell it for $15. We're realizing an $8 gain as compared to a five dollar gain. So understanding what leads to an adjustment of basis could be the thing that could let you know how much of your gang is going to be subject to taxes. And to that end, it's not just a matter of what causes your basis to go up or down. You also, as a taxpayer in many circumstances, can choose the type of method that you use to assess capital gains. And depending on the asset that you sold for a profit, it could have a monumental impact in how much is subject to capital gains tax in the first place. If you're looking on screen, you're looking at an article that talks about the different methods that you can use to, uh, determine your cost basis. One of those is the average cost method, where if you look at a series of investments or purchases that you've made for the same type of asset, like a stock, for example, when you're determining cost basis, when you sell it for a gang, they take the average price that you paid for all of the shares that you purchased at different intervals. There's also a method called the first in, first out method where if you buy something now, where let's say you bought something five years ago at one price, and then you bought something this year at a different price. When you sell it for a gang, in terms of what the IR's uses to determine profit, they operate under the assumption that you sell the first shares first. The opposite of that obviously would be the last in first method where if you bought something five years ago and you bought another tranche of shares in this year and you happen to sell those shares from a tax perspective, the IR's assumes that you sold the most recent shares you purchased first. When determining your cost basis, there's the low cost method where they're assuming you're selling the asset that has the lowest price of purchase first. And then there's the high cost, which is the reverse, where they're assuming that you're selling the share that has the highest cost first. And in all these different scenarios, using one of these methods could be the thing that you can use to lower your taxable burden, even though you paid what you paid and you sold it for what you sold it for. And if you look at a brokerage account, for example, many times they will default to a certain method when assessing your cost basis for a sale. But you have the ability to manually choose the cost method that you use for determining your basis if you alert your brokerage company. So understanding how these work could put you in a situation where you might sell an investment for a gang. And maybe your brokerage automatically uses the average cost method, but you may tell them, I don't want to use average cost, I want to use, for example, the high cost lot method, because you've done calculations to figure out that that is the most beneficial situation for your taxes. So what I want to do is we're going to take a quick break, and after the break, I'm going to give you three quick examples of the ways that cost basis affects your unrealized and realize gangs for everyday transactions in ways that you just wouldn't think before you understood this concept.
[00:12:44] Speaker C: This is the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen. We'll be right back.
[00:13:03] Speaker B: Are you wondering what new money problems you might be overlooking in your financial life? If so, we've got great news.
We've crafted the new money new problems gap finder to identify potential weaknesses in your finances in areas ranging from budgeting, investments, insurance, and even the threat your extended family's finances could pose to your household. Please head to new money newproblems.com to complete it today. Again, that's new moneynewproblems.com. gapfinder. To take the assessment.
[00:13:42] Speaker C: You'Re listening to the new Money new problems podcast. Subscribe now at new Moneynewproblems.com. welcome back.
[00:13:53] Speaker A: All right, we're back from the break, and let's go through three everyday transactions that people do all around the country that have a tax impact, where if you have an understanding of how your cost basis is impacted, you can make decisions that radically reduce or even eliminate your tax burden in many instances, if you're looking on screen, you're looking at an investor who paid $5,000 to purchase 100 shares of stock, XYZ. And they did this at three different times and three different share prices. So they bought 80 shares in January of 2022 for dollar 45 a share. In February of 2022, they purchased ten shares at $60 a share, and in April of 2022, they purchased ten shares at $80 a share. So for their hundred shares, on average, they paid $50 per share. Now, let's say that that $5,000 that they used to purchase it and those shares grew to $10,000 in value. So now they have grown to $100 per share. They bought it when it was at $45, $60, $80. Now it's grown to $100 per share in value. Now, let's assume that they sell ten of those shares for $1,000. And when they look at their brokerage company, they see that in terms of determining their cost basis, the default method that their brokerage uses is average cost, meaning that for the ten shares that they sold at $100 per share, we would subtract what they consider to be a cost basis of $50, because that's the average cost per share. And that means that for those ten shares, they would realize a profit of $50 on each share of stock. Now, with this person understanding the different ways that you can assess cost basis, let's assume that instead of using the average cost, they tell their brokers that they want to instead use the high cost method, where you assume that the first shares that you're selling are the ones that cost you the most. We can go back and we can see that the highest cost that they paid is dollar 80 per share, and they actually happen to buy ten shares at that price. So they took their ten shares that they sold, and instead of having a cost basis of $50, they can use the high cost method to list their cost basis at $80 per share. And that means that instead of them realizing a gain of $50 on each share that they sold, they would instead realize a gain of $20 per share on each share that they sold. That's a 60% reduction in the amount that they'll realize for tax purposes and a significant potential reduction in capital gains tax owed. This is the importance of understanding cost basis and how it impacts different financial investments and transactions that may take place. Now, let's look at a very common example that I see with clients who have, uh, elderly loved ones who might have older homes. If that family member, and if that family member were to die, they'd be trying to figure out what to do with the property. Or maybe the client themselves has multiple properties, and they're trying to figure out what would happen, uh, should something happen to them. Let's look on screen at the example of Tina, who, when she was 45 years old, purchased a home in 1990 for $200,000. And that means that, um, more or less $200,000 is going to be her cost basis on that property. Now, 30 years later, she's 75 years old, and she's worried about passing that home to her son, Steven. She doesn't want him to deal with so much if she were to pass, she just wants to take care of it now. So she adds, Steven's name as owner of the home puts him on the deed, which means that he inherits her $200,000 cost basis. Now, let's assume that, unfortunately, a few years later, Tina dies, and at her death, the home is valued at $500,000. And when Stephen looks around and says he doesn't want to keep that property, he sells that home for $500,000 and realizes a $300,000 gain. Now, this is something, like I said, that is very common, where someone who is well intended puts someone who will puts a person they want to inherit that home as co owner on the deed of a property, not understanding that in doing so, they inherit their cost basis. Now, let's assume that Tina understands that there is another way to do this, and that involves just making sure that you have an estate plan that properly passes this house to Steven upon her death. So now, same circumstance. Tina has a $200,000 cost basis in a home that she purchased when she's 75. She starts to get worried about making sure this home passes to Steven. But instead of adding him as a co owner, she uses proper estate planning and leaves the home to Steven after her death, either through a will or a trust, or some combination of the two. The difference between these two different strategies is when you leave someone, a property or an asset at death, the cost basis that they get on that asset is the fair market value at the date of your death. So since that home has grown to $500,000 in value at the date of death, instead of Steven's cost basis being his mother's, which was 200,000, his cost basis is the $500,000 value at the date of her death. So he now turns around and sells that house for $500,000 and realizes no gain as compared to before, where he would have realized a $300,000 gain. And depending on his capital gains tax rate, if he has as high as a 20% rate, that means up to $60,000 in savings in federal taxes. Between these two strategies, all because of understanding the impact of cost basis and unrealized and realized gainshead. And the third concept that we want to discuss to me would be a little complex to talk about on, uh, a graphic. So we're just going to describe it. We're going to talk in more detail in future episodes about rental real estate and what it means to own it from a tax perspective while you own it, and also what occurs when you sell it. What you need to understand when you own rental real estate or investment real estate as compared to your primary home, is when you have investment real estate. There are a number of different things that can increase or decrease your cost basis in a property. Things that could increase your cost basis are things like improvements that you've made to the home. But there's also concepts that you pay for or take advantage of in your taxes when it comes to investment properties that can decrease your basis. And one of the significant things that decreases cost basis is a concept called depreciation. Depreciation is another tax term where when you have an asset that is in use, in this case an investment property, your tax preparer may depreciate the asset on your tax return over a period of time. So, to make a real basic example, if you had $100,000 cost basis and you took a $20,000 depreciation expense, you may be looking at that house saying it's still worth 100,000, but your cost basis has now been reduced to 80,000. And it's a tool that many property owners use to get tax deductions related to rental real estate throughout the course of owning that property. The problem is, when you use depreciation expense to lower your cost basis and you sell that property, there's a concept called depreciation recapture, where because you're selling it for a gang, that gang factors in the decreased cost basis, and it gives the IR's the opportunity to essentially get some of that money back that you took over the years in depreciation. So we see very regularly, and this is a concept that we're going to talk about in future episodes, which is why I didn't want to do a diagram for it. We'll have a person who has an investment property that has increased in value over the years. They will sell it without an understanding of their cost basis, and they will think that they're walking away with a significant amount of tax free gang on that property, only to find out when it comes time to pay their tax that their cost basis in that property was reduced to the point where a much more significant portion of that sale proceed is subject to taxes at 15% to 20%. So if you find yourself in this situation and you're planning to sell a property, you want to ask and talk with your tax preparer before you sell to understand what your cost basis is in that property. And if you're interested in rental real estate, this is a concept we're going to discuss m much more in the future that you can go into it with as much information as you can to make it a valuable investment for your portfolio. So that's this week's episode. I'm sorry we're posting it late. I'm sorry that the audio may be a little wonky compared to what you're used to, but I didn't bring my studio mic and all that with me when I traveled. Uh, so bear with us, but hopefully you got some value out of it. I'm looking forward to next week's 100th episode. Don't forget to send in your biggest money mistakes to
[email protected] or on our socials. And I'm looking forward to the celebration with you, and I'm thankful for you as a community, and I can't wait to share this moment next week. Talk, um, to you then.
[00:22:40] Speaker B: Let's get some money from new money, new problems. This was the new money, new Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
[00:23:02] Speaker A: Let's get some money.
