1076: Specific Identification of Shares by The Mad Fientist on How To Reduce Your Tax Burden on Taxable Investments


This is optimal finance daily episode. Ten seventy six specific identification of shares by the mad scientist of MAD SCIENTISTS DOT COM. And I am Dan. I'm your host here on optimal finance daily. And this is where I read to you. From some of the very best personal finance blogs on the planet and thanks to fundraise for their support as you may know a portfolio that's well diversified has better chances of long term success it should contain investments in various asset classes that include real estate with real estate historically acting as an effective inflation buffer. Did you know that fundraise was awarded the title of Best Real Estate Investment Platform? Twenty nineteen from the fintech breakthrough awards. I'll share why at the end of this episode. Visit fundraise DOT COM slash o F T. That's F. U. N. D. R. I S. E. DOT COM slash O. F. D. to have your first three months of fees waived for now. Let's get right to the post as we start optimizing your life. Specific identification of shares by the mad scientist of MAD SCIENTIST DOT COM. A few months ago I wrote a couple of articles about harvesting investment gains and losses for tax purposes in the tax loss harvesting post. I described how it can be beneficial to sell investments for a loss in order to use that loss to reduce your taxable income conversely in the tax gain harvesting article. I showed that in some situations it may be a good idea to sell your investments for gain to increase your cost basis. What I didn't tell you is how to structure your taxable portfolios so that you can easily sell the investments that have depreciated in some years and those who have appreciated in others. Today I will do that cost basis when you buy an investment. The price you bought the investment for is the cost basis note the cost basis can be adjusted for stock splits dividends etc. The cost basis is important because it is used to calculate how much taxes owed when an investment is sold accounting methods. When you sell an investment there are various accounting methods that can be used to determine the cost basis the three types at vanguard offers our average cost. Fifo first in first out and specific identification to illustrate the differences between these various methods. Let's create an example scenario to play around with assume you purchase one hundred shares of investment acts in your taxable portfolio every year for three years in year. One you purchase one hundred shares of the investment for ten dollars per share when you buy the investment again the following year. The price has risen to twenty dollars per share. So you buy one hundred shares at twenty dollars per share. Finally in year three the price has risen again and you purchase one hundred shares of the investment for thirty dollars per share. Let's take a look at what would happen if you decided to sell. Fifty shares using the three different accounting methods average cost the average cost. Method simply. Takes all of your cost basis values and averages them to produce a single cost basis for all of your shares in the example provided the cost basis using the average cost method would be twenty dollars per share. This is a reasonable way of doing things. But what if the price of the investment falls to twenty dollars in year five and you'd like to harvest those losses on the shears you bought in your three with average cost accounting? You wouldn't be able to do that because your average cost basis would be twenty dollars so selling fifty shares of the investment for twenty dollars wouldn't resulting any gains or losses first in first out. Fifo the second method uses the cost basis of the oldest shares in your portfolio. I I e the shares that go in I are the first to come back out so again. In our example scenario you still wouldn't be able to harvest your losses using the Fifo method either because if you sold fifty shares when the price dropped twenty you'd actually create a taxable gain of ten dollars per share because you'd be selling the shares that you bought in year one for ten dollars per share specific identification luckily the final accounting methods specific identification allows us to specify which shares we would like to sell to harvest our losses in year five when the price falls back to twenty dollars. We would simply specify during the sale that we would like to sell the shares that we bought in year three four thirty dollars per share. What if we instead wanted to harvest our gains? When the price was at twenty the specific identification method. Would allow us to do this as well. Because we simply choose to sell the shares that we bought in year one for ten dollars per share instead changing methods at vanguard the default accounting method for mutual funds is the average cost method and the default for brokerage shares is FIFO. You can change your cost. Basis methods during the execution of a trade it makes sense to update your default cost basis method for all taxable investments to the specific identification method to do this in vanguard you simply need to select the account maintenance option under the my accounts tab and then click the cost basis methods link taxable accounts. Please note you only need to worry about cost. Basis in your taxable accounts cost basis is irrelevant in tax advantaged accounts like four one ks and IRA's because gains within those types of accounts are not taxed when shares are sold conclusion as you've seen specific identification of shares is the best cost basis accounting method for those wanting to minimize taxes. Although it adds an extra step when selling your investments having control over exactly which shares you sell is well worth the additional effort. You just listened to the Post titled Specific Identification of shares by the mad scientist of mad scientists DOT COM. And thank you once again to our friends. At Fund rise getting started with real estate doesn't belong to a secret group of powerful and wealthy individuals fund rise is the first online platform that makes real estate investing accessible to everyone. On fundraise you can personally select the properties. You'd like to invest in which ranged from downtown high rises and commercial renovations to multifamily apartments. All of the projects on fundraise are carefully vetted and managed by fundraisers team of real estate professionals the platforms investor I model eliminates extraneous costs. Therefore saving you time and money when you choose to invest visit fundraise DOT COM slash O. F. D. that's F. U. N. D. R. I S. E. dot com slash o f t to have your first three months of fees waived and. That's it for today. Thank you so much for listening and for subscribing as well hope. You're having a terrific weekend. I'M GONNA see right back here tomorrow. Where your optimal life awaits.

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