Welcome back to Portfolio Rescue, where we always appreciate your questions, comments, feedback, or email us. Askthecompoundshow@gmail.com. Today's show is sponsored by AcreTrader. AcreTrader allows you to buy farmland across the country. A few benefits here. Inflation, coming down, still a little high though, right? Now, while farmland has no correlations to toxic bonds, it does have a positive correlation with inflation going back all the way to the 1960s.

A couple other benefits here. Low fees, no use of leverage. I think we've seen, we've learned this year, leverage is not very great, right? No leverage use here. If you want to learn more about investing in farmland, go to AcreTrader.com, and to learn more about the risks, it's AcreTrader.com/company/terms.

Duncan, tough year in the markets. We've been talking about it a lot here, right? Yeah. But if you look at the returns now, it's not that bad. John, throw up my chart here. Speak for yourself. Well, obviously, I'm saying this after the seventh bear market rally we've had, but these are year-to-date returns.

Okay, so value stocks, I'm using the Vanguard value fund here. It's up like more than 1% on the year. It's positive. The Dow, this is all through close on Thursday, okay? So whatever's happened today, not on here. Dow's down just 3% on the year. Total returns, small caps, Russell 2000, usually pretty risky.

Down less than 9%. International stocks, huge comeback here, even with the dollar in a strong year. Down like 12.8%, actually outperforming the S&P now, which is down 13 and change. Growth stocks, the one bad performer, down 27%. So as long as you're not all in on tech stocks or all in on oat milk stocks this year, it's a down year correction, but not a calamity anymore, right?

Now, obviously, again, I'm saying this during a bear market rally, so maybe I'm jinxing things here. Merely pointing out where we are in context of where we've been, not all that bad, right? If we get some sort of Santa Claus rally here, I can't imagine if the Dow closes positive for the year.

It's going to add to how bizarre this year has been. But really, if you've had a diversified portfolio, it's not been fun, but where we are today, not nearly as bad as where it was. How's that? Are you wanting to make a call? No, no, I'm providing context where we are.

I'm not good at predicting the future. It's hard enough to tell what happened in the past. So there's no opinion on where the Dow is going to be at the end of January or anything like that? I'll give you my 2022 Dow point forecast on December 29th. How's that sound?

Other than that, I got nothing. Let's do a question. Okay. First up, we have a question from Nick who writes, "We own a cash-flowing rental property with a sub-3% mortgage and 28 years remaining. On the August 18th episode of Portfolio Rescue, Barry said real estate more or less returns zero net of inflation.

However, does this statement take into account the leverage provided by a mortgage? Return comparisons between stocks and real estate seem to favor stocks, but it's not clear whether these comparisons ever take into account mortgage leverage. Also, how does one factor a mortgage rate that is below current inflation into the calculus?

On a 20-year time horizon, would it really theoretically be better to sell the property and invest the proceeds into some combination of stocks and bonds?" We talk a lot here about the types of questions we get, and we've mentioned we get a lot of questions on bonds lately. We've effectively gotten no questions on the stock market for like the past six months.

People have stopped asking about the stock market. It's true. But there's a lot of questions about the housing market lately too. So unfortunately, the return stream for housing is very difficult to understand. So John, throw up my first chart here. This is from Robert Shiller. Before the late '90s, early 2000s, no one really knew what the long-term returns for housing as a whole were until Robert Shiller put this together.

Now, this is real home price index, which means after inflation. He took this back to 1890. I don't know what housing in America looked like in 1890, so I don't know how relevant this all is, but this is what he did. The returns after inflation are probably not as good as most people would assume.

So from 1890 to 2022, the latest update, the housing market in the United States is up a total of 120% and change. That's 0.6% per year over the rate of inflation. Most of that return, as you can see from this chart, has come in the last three decades. So from 1890 to 1989, 100 years, the U.S.

housing market appreciated 30% in total, less than 0.3% per year. Again, that's after inflation. So you've got an inflation hedge, not much of a kicker. Then from 1989 to 2022, so the last three decades and change, it's up more than 70% or like 1.6% per year above inflation. Now, some people may look at these numbers and think that's god-awful.

I thought it would have been way better than that when you look at the big numbers for housing. I personally think beating the rate of inflation while holding a fixed-rate mortgage and having a roof over your head is not that bad of a deal. But it's also important to note that Shiller's data doesn't take into account the actual experience of someone buying and selling a home.

Let's say you timed the housing market pretty good, and 10 years ago you bought for $300K in Boise, Idaho. Now you can sell that house for $500K. At the time, you put 10% down, so you put $30,000 down. You sell that house today for $500K, what's your return? Well, some would say it's $200K, right?

$200K over $300K, so we're talking like a 67% return. But wait, what about the leverage involved? You only put $30,000 down, right? So is your return more like almost 6X because you turned $30,000 in 200K? Again, not really, because each month you paid a mortgage, you paid insurance, you probably did some upkeep, maintenance, landscaping, you probably bought some furniture, maybe hired an interior decorator, made some improvements.

So then when you bought the house, you probably paid some closing costs. When you sell the house, you pay some realtor fees and other closing costs. So I'm not sure that anyone actually knows what all the all-in costs are for their house. I don't think anyone really keeps track of them.

Maybe a few spreadsheet warriors do. The other thing is, you have to live somewhere, so wait a minute, why don't we net out what my rent payments would be, what my mortgage costs would be, and I just guess no one on the planet knows what their all-in return is, because it's not like a stock or a mutual fund where you just buy it and you know the expense ratio every year, and you can just calculate it easily, right?

Plus, housing is a form of consumption. That's why it's so difficult to compare housing to other financial markets like stocks and bonds. Now this question is more about a rental property, right? So maybe that's a little easier to figure out, but I think there's still a lot of unknowns.

And I think a lot of this comes down to your, we talked about this in recent weeks, your talents for complexity. Now, rental houses can offer a decent yield on your investment, right? You have the ability to raise rents over time, so that's an inflation hedge. Hopefully the price is gonna go up a little bit, even if it's like Shiller long-term data says, a couple percent over a little bit, a smidge over the inflation rate.

You're building equity through accumulation and then paying down your principal. We've talked about the big risks before, concentration, illiquidity, plus there's a headache risk involved if something breaks, or you can't find a tenant and can't fill it, the pipes burst, that sort of thing. I guess you could pay a management company to handle a lot of that heavy lifting for you, but that eats into your returns as well.

I guess it really depends on the trade-offs you want to have. Your index funds are never gonna call you in the middle of the night and say, "Hey, my AC broke on the unit. Come fix it for me." I do think, though, there are benefits to owning real estate.

Like, you don't have five days a week where you have a bunch of crazy people trading your house day in and day out and telling you the price. "The price is down 1% today." "No, it's up 1%." "No, it doesn't move a lot." So, I think it's a lot easier to think and act for the long-term real estate, even if it does have lower returns than the stock market.

But I think for a lot of people, there's just so much more idiosyncratic risk because of your local economy and all these things, and you have not only the macro stuff to deal with inflation and interest rates and economic growth, but you also have the local economy and the location and tenants and all this stuff.

So, I wouldn't try to talk someone out of it, but I think making the comparison between stocks and real estate is gonna be very difficult to do, unless you're really tracking this stuff. And so, I think a lot of it comes down to how much you're willing to put in to being an actual landlord.

Also, this might be a first-world problem, but I would think that there are things that you wouldn't expect to encounter that you might encounter. Like, if you have a really cool vacation home, suddenly you have a bunch of friends and family wanting to stay there. You were planning to rent it out and make money off of it on Airbnb or something.

Next thing you know, you have a bunch of weeks of the year taken up by friends and family, right? Yeah, those leeches. What are you doing? You're not using my summer vacation home. Come on. You give them a 20% discount, right? There you go. Yeah, that's true. So, yeah.

So, I know people who ... People like the tangible nature of owning a home and owning rental properties, and I understand that. And some people just don't trust the stock market. I don't think there's any one way to succeed. I think you just have to understand the trade-offs when you get involved in something like this.

Yeah. That makes sense. Let's do another one. Okay. Up next, we have a question from Matt, who starts off with, "Love the podcast. Keep up the great work." Thank you, Matt. Yeah, thanks. Also, this is a good ... This is an opportune time to mention, if you use Spotify, they're doing the yearly Spotify year-in-review type thing, where it shows your top-listened podcasts over the year.

If we're one of them, or the Compound Friends, Animal Spirits, whatever, share that with us. I'm not sharing it. They have the same feature on Apple now. They just stole it from Spotify, and it did all the music I've played. It was all Disney songs and zombie songs for my kids.

It was ... It just totally screws up everything, because all my kids want to listen to. They listen to more music. You should still share it. I'd like to see that. Not great. Zombies 3 soundtrack from Disney. Okay. So, Matt writes, "Recently, I've been hearing that the wealth effect is more tied to people's homes than stocks.

This argument seems to be related to the fact that a large percentage of stock ownership is in the hands of so few. However, it seems like average 401(k) balances versus average home equity are fairly close. I would imagine that most people that own a home would also likely have a 401(k).

I would also tend to think that home equity and 401(k) balances would trend together, as both are likely to increase over a lifetime. But to be honest, neither of these things affects how I personally spend. That part has much more to do with how secure I feel in my job and my expectations about raises and bonuses.

So, is the wealth effect just nonsense? Maybe it's just correlated because when housing and stocks are going up, pay and bonuses are likely going up, too." I like this question mostly because I kind of agree with the premise. So, the wealth effect, for those who don't know, is just, if your stock portfolio is going up, or your house price is going up, maybe you feel better about yourself, and you spend more money.

And there's this idea where that's just a self-fulfilling thing. And then, when those prices go down, maybe you don't spend as much money. I do disagree with the idea that the stock market and the housing market are similar for most people. So, John, throw up the first table here on net worth by different levels of wealth.

A lot going on here. Allow me to explain. The top 10% in this country, in terms of wealth, holds 70% of the net worth. The bottom 90% accounts for 75% of the debt in this country, which doesn't sound like a great trade-off there. The reason for this is because the top 10% owns most of the financial assets, while the bottom 90% has more of their net worth tied up in things like real estate.

So, John, go to the next table here. This is just looking at real estate and stocks. So, the top 10%, in terms of wealth, owns almost 90% of the stocks. The bottom 90% owns more than 55% of the real estate. It's interesting, when you look at the top 1%, they own almost more than 50% of the stocks, and less than 14% of the real estate.

So, it's not completely balanced, but the lower and middle classes have most of their wealth tied up in their home, while the wealthy class has the majority of their wealth tied up in stocks and bonds, on a relative basis. So, if you think about only, again, the top 10% own 90% of the stocks.

I think it's something like 50% of people in the households in the U.S. own stock in any form. The homeownership rate is 65%. So, I would argue the housing market has a far greater impact on wealth than households than the stock market does. If you think about the 2008 disaster, that's why it was so bad, because that's why the middle class got hit so bad, because the housing market got hit so bad.

I do agree that the wealth effect is probably overstated. It's kind of like a correlation is not equalization thing. When the stock market is rising, the margin debt is up, too. And people think, "Oh, the margin debt is so large, people are overleveraged, that has to fall, and that's going to wreck the stock market." But actually, it's like a concurrent thing.

The margin debt is up because the stock market is up. And then, when the stock market goes down, margin debt goes down. I think the same thing is true of the wealth effect. So, let's say in the next year, the housing market goes down 10%, and so does the stock market.

But you can still pay your mortgage, you still have a job, you're still saving money. Does that 10% decline in financial assets really change your life in any meaningful way? I guess maybe you can't take as much out of your home equity line of credit to potentially do some upgrades on your house or whatever.

Maybe you could make the case that people save less when their investments are doing well, because they assume the returns of doing the heavy lifting for them. I think it's probably more about confidence than anything. When the stock market and the housing market are doing well, the economy is doing well, too.

So, people are probably making money and feel more confident. And when those things are doing poorly, the economy is doing poorly. It's not a perfect one-to-one, but I think this year is a perfect example. The stock market has been in a bear market pretty much since the beginning of the year.

The stock market peaked on January 3rd. People are still spending money like crazy. People are still traveling, they're still spending tons of money on stuff. Black Friday was a boom again this year. And I don't think those 401(k) balances are really stopping people from spending money. So, I think it probably does have more to do with employment picture and raises and bonuses and all that stuff.

And a lot of times when the economy is doing well, the stock market isn't. It doesn't always work like that, obviously, this year. But I think as long as people have jobs, they're going to be willing to spend some money. Yeah, it seems like it. New York is certainly booming right now.

I look out over Bryant Park and it's full. Right. Do they care that their growth stocks are down 27% this year? Probably not, right? They're still going to pay for those ice skate rentals? Yeah, seems like it. Pay for those $13 beers in New York? Sure. Do another one.

Okay, up next, deja vu, we have a question from another Matt. So, Matt writes, "Why would the 10-year T-bond pay out a lower rate than the 2-year? Or would the 30-year pay less than the 10-year?" I realize this is a bit of a Google-it question, but I can't get a straight layman's term answer on this.

I've always associated longer term with getting paid more yield, as it means I potentially lose access to my money for a longer period of time and should be paid accordingly. This is a good question. We have a lot of people who wonder about this kind of thing. This is the inverted yield curve, right?

Yes, it is a perfectly reasonable question to ask from a textbook perspective. All else equal, you would assume that you would get a higher yield from a bond that takes longer to pay off versus one that takes shorter, because so many more things can happen in terms of interest rate changes and inflation and economic growth over 30 years than, say, 30 months.

So, in a normal economic environment, if there is such a thing, you would expect 30-year Treasuries to yield more than 20-year, which you would expect to yield more than 10 and 5, and all down the line. That just seems like common sense. But, at times, we find ourselves in the current situation, where short-term yields are higher than long-term yields.

So, John, throw up the chart of Treasury yields here. You can see, three 6-, 12-month Treasury bonds, or bills, are now paying more than 5-, 10-, and 30-year bonds, which seems to make no sense. Those ones are way more volatile, way more risky, yet you're earning a higher yield at the shorter end of the curve, and by a pretty decent margin.

So, why does this happen? Bond yield spreads, the difference between certain maturities of bonds, are typically used to gauge the health of the economy. So, wider spreads, when longer-term yields are higher than shorter-term yields, lead to an upward-sloping yield curve, which would indicate healthy economic prospects. So, you'd think higher economic growth in the future, higher inflation.

Narrower spreads, which is a flatter, even an inverted yield curve, they call it inverted, when it's lower, when the shorter-term are higher than the longer-term. We really missed our opportunity to use a Top Gun picture here, being inverted. That's most likely a sign that growth is going to be slower in the future, and inflation.

So, the bond market is predicting that inflation is going to be lower in the future, and maybe growth is going to be lower. And typically, they think this means that we're heading toward a recession. So, John, throw up the next chart. This is the 10-year and the 2-year. This is just the 10-year minus the 2-year.

You can see, as long as it's below that black line, that means it's inverted. And you can see, I circled the parts on the chart here, the gray bars after it are recessions. So, you can see, when this happens, historically, over the last 40 years or so, every time the bond market gets inverted, when shorter-term yields are higher than longer-term yields, then we've gone into a recession.

And, John, fill the next little table up here. I looked at the last few times this has happened. The start of the yield curve to the start of the recession. You can see it ranges anywhere from 10 to 24 months, and the average is about 17 months. So, if we believe the bond market, what it's really saying is growth and inflation are probably coming down in the future.

Does the bond market always get this right? Historically, with the yield curve, yes. Does that mean it's always going to happen in the future? I don't know. Even if the yield curve does predict a recession, we can't predict when it's going to happen, how the stock market will react to it, the magnitude of the recession or the stock market's impact, and what the Fed will do in the meantime.

The Fed piece is probably the most important part here right now. The Fed is effectively inverting the yield curve on purpose. They're raising short-term rates, and the long end of the bond curve is saying, "We don't care. We don't think inflation is going to be high in the future.

We're stuck here below 4%." So, I really don't know if there's any predictive power in this anymore, but that's why short-term rates are higher than long-term rates right now. The Fed is raising short-term rates, and the bond market that is not controlled by the Fed is saying, "That's fine.

Go ahead. We're going to stay where we are." So, I don't know who's going to blink first. It's Jerome Powell versus the bond market. O'Reilly: Yeah, who knows? Do you think that COVID completely ruined the yield curve as an indicator? I know we had Campbell Harvey on to talk about that a long time ago.

Lewis: Well, if you think the yield curve can predict a pandemic, it's pretty darn smart then. I'm just not going to get in the way anymore, then, if it can do that. But it did invert, and then we had a recession. So, I think that's, again, a coincident indicator.

It was kind of lucky. And if the Fed keeps raising rates and the long end of the curve keeps going down because it thinks inflation is going to be coming lower, it's just going to get more and more inverted. And we're closing in. It's the most inverted it's been since the 1980s, when you had really fast-moving rates by the Fed.

So, we shall see. Hasn't been wrong yet. O'Reilly: Ominous. Lewis: Fun times. Let's do another one. Up next, we have a question from Brennan. "Does tax-loss harvesting have to be done in the same year? For example, I sold stock earlier in the year for a loss. Do I have to sell my winners in this calendar year in order to offset the capital gains?" O'Reilly: Alright, a question that's beyond my level of expertise.

Let's bring in the tax man, Bill Sweet, yet again to get to the bottom of this. Hi, Bill. Sweet: Gentlemen, I'd like to welcome you and the listeners and viewers to my kitchen, where the coffee is hot and the beer is cold. Welcome. O'Reilly: I notice you have coffee and not a beer, though.

Sweet: Yeah, well, it's not noon yet somewhere, and I was thirsty, so I went to town. O'Reilly: Alright, Bill, there are some weird tax timing issues. Like, you always tell me, "Hey, Ben, you have until April to put money into your SEP IRA." So, there are some weird things where you can go past the end of the calendar year.

Does tax-loss harvesting look like this, or not? Sweet: Yeah, well, I'm going to correct you there. You've got until October, if you file an extension. O'Reilly: October? Oh, okay. Sweet: Let's get really crazy. O'Reilly: Alright. Does tax-loss harvesting work in the same way, or not? Sweet: So, it does.

So, great question. And in order to get your tax losses in for the year, so let's start here, for Brennan. You do need to execute by December 31st of 2022, so that's the most important thing. And this year, Ben, that happens to fall on a Saturday, so I might recommend doing that at least a day before, getting in during the workday on the 30th.

And I think the market's closed after noon on the Friday before New Year's. Correct me if I'm wrong. Ben, do you know that off the top of your head? I do not. Sweet: I've got nothing. But by that time, I'm totally checked out, Bill, for the last 50 years.

I'm sorry. O'Reilly: We've moved on. So, and just a point of emphasis, too, the tax law generally recognizes the trade date, not the settlement date, so that's important, the legal date that it falls out. But Ben, I've got two neat things to point out for Brennan. Number one is everything that's out for the calendar year.

So, if you do a trade on January 2nd, you do a trade on December 29th, all that just gets mushed into a giant bowl of spaghetti when you're trying to calculate, "What is my capital gains tax?" So, that's extremely important to understand, that it's really the full year that matters, and then each year the calendar flips over, and we move on.

You cannot file on a fiscal year basis from June to July as a U.S. taxpayer. They're like, "Nope, January 1, December 31." So, that's the neat thing. And you only pay tax on the net. And so, you can generate short-term capital losses, offset long-term capital gains, and everywhere in between, you add it all up and what's left, that's what you pay tax on in April.

So, that's the first key point to understand. What are your questions about that, gentlemen? That makes sense to me. I see someone in the chat here says they're a farmer because they've been harvesting losses all year long, and I think this is definitely the year for it. The problem for a lot of people this year is, "Do we have gains to offset those losses and actually use them?" Yeah.

And so, that brings us to the second part of Brent in question, is he's like, "Well, look, if I've got my losses, do I need to generate gains in a year or do these go away?" The answer is no. You can deduct up to $3,000, only $3,000 of capital gains, excuse me, capital losses against your ordinary income.

And that's a neat thing. It's been set in the tax code since 1978. Fun fact with inflation, that would be indexed to $13,700 today, an increase of 360%. You know what we should index it to? Bear markets. If there's a bear market, you can take more losses. That would be great.

That'd be great. But ultimately, any amounts that you don't use against gains, and then any amounts that you do not apply above $3,000 against your ordinary income, those carry forward to the next year. And so, Brennan, hypothetically, if he realizes $9,000 of net capital losses, he uses $3K against his ordinary income.

Now, $6,000 starts on his balance sheet on January 1, 2023, and then he can recognize the gain next year and still be offset against the loss. And that's a neat thing. And I would recommend thinking about arbitrage there, because ultimately, if my ordinary income rate is 24%, if it's 32%, that $3,000 generates some arbitrage opportunities versus the 15% capital gains rate.

So I think in a year like this, Ben, one way to make lemonade out of lemons or make regular coffee out of decaf coffee, throw some caffeine in it, is try to hit that $3,000 loss limit, push your gains off until January. I think that's a great thing to think about.

That makes sense. All right. I love a good arbitrage. Yeah, it's good. It's good stuff. Let's do another one. Let's do it. All right. Up next, we have a question from Rob. I just retired this year, congrats, at age 55, and I'm looking into various-- That's our not-to-brag-of-the-day, to retire early.

Yeah. Good for him. Yeah, at 55, that's good. And I'm looking into various tax planning strategies. One plan would be to withdraw money from my 401(k) and then deposit the max allowed into my HSA. I qualify for the rule of 55, so there would be no 10% penalty. No idea what they're talking about.

Wouldn't this be tax-neutral in the current year? 401(k) withdrawal is taxable, but HSA deposits are deductible. This seems like a no-brainer, or am I thinking about this wrong? I would also like some clarification on paying taxes on Roth conversions. If I convert some money from my 401(k) to my Roth in January, would the tax for that amount be due in the first quarter of the year, or could I spread out the payments throughout the year?

All right, Bill, you're going to have to send this guy a bill after this one, I think. Yeah. All right. So this is, I mean, there's no cross-currents in terms of going from one retirement account to another, as long as, I mean, the money is kind of just switching hands.

That's doable? He can go from the 401(k) to the HSA? I mean, yes. I mean, not directly, so that's the key. But, Rob, you've got a lot going on, my man. I might stop what I'm doing, pick up the phone, dial 1-800-CFP. And we can't give you specific advice.

This is our business, after all. It's helping people like Rob navigate these things. But we can riff on general topics. So let's start there, Ben. Yes, an HSA, $8,300 contribution for a family HSA, that can directly offset up to $8,300 of a 401(k) distribution. So if you time that, both in the same tax year, those net out to zero and you're good to go.

And the HSA, we don't need to go into, but ultimately, if you're using that for medical expenses, you don't ever pay tax on that amount. So that, I think, is a neat thing. I think it's a great place to start, Rob. And the rule of 55 thing is just, he's talking about not having any penalty for taking money out of a retirement.

Yeah, that's it. That's it. So 59 and a half. Why a half-year? I have no idea. Just some genius in the tax code back in the pre-war days. That is bizarre. It seems like a five-year-old made this, because my five-year-olds celebrate their half-birthdays. They're always like, "When's my half-birthday?" They think it's a real thing.

It seems like someone in the tax code did this, too. We want our politicians to focus on kitchen table issues, and maybe that one literally came from the kitchen table. But it does really complicate things, because if my birthday is July 2nd, I have to wait until the next year in order to get to that 59 and a half?

It's insane. Can we just get to 50? Call your congressperson. But ultimately, what the rule of 55 allows you to do is access distributions before age 59 and a half. And the 55 just refers to, there's a four-year window where that's possible. And basically, you do have to actually be retired.

There's a couple of other ways that it goes. But ultimately, it ends up being a relatively small amount of money. And so, I wouldn't necessarily rely on that to save the bacon if you're planning on retiring at 56 or later. All right. And let's also tell Rob, if you're getting this much into the minutiae, you probably might need to talk to someone, a CPA or an advisor.

Yeah. We're doing this for fun here. But yeah, there are spreadsheets involved. But Rob's second question was relating to conversions, right? And so, the second part of his question was if I do a Roth conversion in January, is that spread evenly throughout the year? And let's go back to the capital gains conversation.

It's the same thing that a conversion in January is going to be taxed the same for tax purposes. I'm going to get to the distinction in a second. All the way out to December, it really doesn't matter. Your tax is calculated on your total income for the year. So, where that happens in the year is not relevant as long as it happens Jan 1 to December 31.

However, what Rob might be getting at is there are estimated taxes due potentially on when you take the distribution. And if you're timing something in January, that falls in Q1. Q1 estimated tax is due in April. And that does need to be spread more or less evenly throughout the year.

There are two rules of thumb. One is you need to have at least 90% of your current year income, or there's a safe harbor 110% of the prior year income. So, if you're doing a conversion in January, I think it would make sense to withhold at least a quarter of that amount by April 15 to avoid the estimated tax penalty.

At least taxes aren't complicated, right? It's almost like people get paid to do this. So, fun fact for you both gentlemen. The federal budget for estimated tax purposes, the quarters go January through March, April to May, put a pin in that, June, July, August, and then the Q4 is September, October, November, December.

Ben, why is this the case? Why did this kitchen table nonsense happen? Why do I have a quarter involving Q4? I always forget when I'm supposed to make my payments. I have to remind myself. Yeah, it's June 15th. The reason, and I'll give you a hint, the federal budget turns over on September 1, or October 1.

So, they do this thing where they shorten the quarters. They have this extra long quarter at the end. In just one year, they needed to make some budget and they were like, "You know what? Let's have a two-month quarter so we can get the payments in time." Well, I know this.

My brother works for the government. He says- Oh, so it's his fault. Well, no. When they get to September, he says, "Listen, we have this much left in our budget and we have to spend it. Otherwise, we don't get our new budget." Yeah, yeah. In the Army, that was it.

That, I think, is actually the explanation for a lot of efficiency. It's one thing when I counsel people on business types. One of the beauties of the pass-through LLC structure, for example, Ridd-Holtz Wealth Management LLC, the net profits are the net profits, right? So, there's no incentive to spend the money because it's your money.

So, I think that's a great way to run a business. All right, we got one more. Okay. Last but not least, we have a question from Hadley. "My wife is taking," and this is a two-parter, so stick with us. "My wife is taking a year off from work to care for our child, which means our income is way down.

We are both 45 and I have about $300,000 in long-term capital gains and a salary of $65,000. What are some strategies I can use to try to minimize our current year taxes while also reaching the goal of harvesting as much capital gains at the 0% rate as possible? I've increased my contributions to my employee-sponsored 401(k) with no match to lower my taxable income as much as I can, given our expenses.

I plan to use some of the gains to max out our Roths this year, $3,000 left, as well as next year." Page two. "Is there some rough formula for figuring this out? What I have landed on is $83,349 max for 0% capital gains plus the standard deduction of $25,900, giving me a max AGI of $109,249 for the 0% capital gains rate and 12% tax bracket.

Is that correct, or am I just some idiot reading too much on the internet who needs to talk to his CPA?" These are some next-level questions from listeners this week. I know, yeah, this is a lot. "As an aside, if I figure this out, would it potentially be better for my wife to stay out of work for the rest of the year due to the one-off tax benefits, or maybe take a job the last month or two, which would bump up our income $4,000 to $5,000 a month?" Yeah, this one's a lot.

Getting out of the minutiae here, the whole idea is we have these gains. They'd never even mentioned how they got the $300,000 gains, so kudos to that. That's enough to brag, yeah. Yeah, we've got some tax ninjas that work here, obviously, but they want to lower their taxable income.

So how do they do this? Because the idea would be lowering the taxable income means paying less on those capital gains. Is that the idea? I think so, but Hadley's on to ... The first Hadley I've run into in my career, by the way. A strong name, I enjoy it.

Is that like a Scottish name? I wish I'd had it for my son. Maybe, yeah. That sounds like a Highlands name or something. Yeah, that's some good stuff. What he's getting at is how there is a neat thing that happens if you happen to be in the 12% tax bracket, and Hadley mentions the dollar amount where that happens, about $89,000 of taxable income, and then you can add a standard deduction on top of that.

The capital gains rate at that income range is zero. It's 0%. So we, as a short form, say 15%, the capital gains rate, if you're not making a whole poop ton of money, is actually 0%, and that's a great thing. I think that's an awesome thing for you as taxpayers.

And what Hadley appears to be getting at is how do I maximize the benefit of that 0% tax rate? I was not prepared to do a chart, so I just wrote one down, and it's not going to work at all, but what I want to illustrate here is the effect of stacking.

Did you draw that on a napkin, Bill? I did. This is a kitchen table conversation we're having here, guys. But ultimately, it's the effect of stacking. So let's start with a 401(k). Hadley mentioned he made $65,000 pre-tax. Let's say, hypothetically, he gets close to the 401(k) target. Duncan is going to lose it on the production value.

This is not professional. I think it's working, though. And so his net income after 401(k) is about 45k, right? So that's stack one. Let's think about that. You're taxed on your taxable income. 401(k) is the deduction, guys, right? So that's super cool. Now let's flip this puppy over. I calculated that Hadley can realize about $64,000 of capital gains tax tax-free.

That sounds pretty awesome, right? So if you're sitting on 300k, a 0% tax rate is pretty awesome. How does the math work? First, you have to stack that on top of your ordinary income. We just calculated that. Then we get to deduct a standard deduction of $25,900. And then the tax rate gets calculated as this.

The $19,000 that's left after the standard deduction, that gets taxed at 10%. That's pretty awesome. And because Hadley's below the $83,349 limit for the 12% tax bracket, the capital gains is all taxed at zero. If he crosses this threshold, the amount above it, $1,000, is going to get taxed at 15%.

So maybe you want to leave some wiggle room there. But ultimately, stay below this line, and you pay $1,900 of tax on $129,000 of income. That calculates to 1.5%. That's what I think he's getting at. And that's more or less the way it works. The key here-- Hadley's going to write us in and say, "Bill, can you mail that to me, please?" Stacking.

I guess he can always pause it. This is it. So again, we do need to send invoices. This is next level stuff that we're talking about here, guys. Good work. But impressive for, again, that level of gains. And good for you for asking the question, Hadley. Yeah. Can I hit on something at the end?

Hadley's like, "Hey, my wife's thinking about going back to work." Yeah, I didn't get that part. That is a family decision. Ultimately, yes. This would screw up all my beautiful tax math, right? But the tax rate is-- these questions drive me insane. Because your tax rate is never 100%.

You are always better off going out and earning the money. And so even if it's $1,000, $5,000, whatever it is, go out, earn that cheese, bring that bread home, sit down, upgrade your coffee, put it into a Rotary-- Right. That's saying, "Should I not earn $5,000 because I have to pay $1,000 of it in taxes or whatever it is?" Exactly.

So your tax rate is never going to be 100%. And ultimately, I think economically, everybody's better off when folks are out there in the workforce making stuff happen, making things move and shake. But taking care of a child is no small feat. I think we all know that. So I would make a family decision and ultimately bend the tax math around what you guys want to do with your life.

I think our new rule is going to be anytime we have more than four numbers in a question, Bill's sending you an invoice. Sorry. He's a CFO. He has that right. I'm going to scan this puppy. Yeah. And you will hear from QuickBooks Online. Let's do it. All right.

We have a few more shows this year. What do we have? Three more shows, Duncan? So we're out of here? Yeah. All right. Remember, if you're listening to the podcast, leave us a review. Thanks to Bill again for coming on. Leave us some comments in YouTube here. Compound merch is idontshop.com.

Keep those questions and comments coming. Ask the Compound Show at gmail.com. Maybe ask us a question about the stock market, right? We're sick of questions about bonds. Yeah. I never get sick of questions about tax. Tax ninjas, unite. Let's do this. See you next time. Thanks, everyone. Transcribed by https://otter.ai