Investing "gotchas" you didn't know about

[RedmondStash]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

[bmjohnson35]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

Interesting. Let's say you want to sell shares of an IRA fund and buy shares of the identical fund within the 30-61 day period.  For example, you sell 5k in shares in Jan. to reduce taxable income of previous year AND buy 5-10k of identical shares within the same IRA acct.......within 30-61 days - if you don't care about writing off potential losses associated with the sale, is there any penalty/rule for this situation or even the reverse (buy $5-10k and then sell $5k)?

[iluvzbeach]

I don’t think RedmondStash is talking selling and buying both within the IRA. I think he is saying selling taxable and within 30 days buying the same fund within his IRA.

[iluvzbeach]

I have one to add. DH retired six years ago and was no longer able to contribute to a 401K, so we started maxing out an IRA contribution for him and we’d do it in January each year (you know, invest early & often, yada yada.) Well, my income increased one year to the point that his IRA contribution was no longer deductible. I stupidly didn’t bother to do a back door Roth conversion for these funds and just left them in his IRA thinking we’d be able to take the full amount of the contributed funds out at some point tax free. This is the year I decided we’d take those funds out and in conducting research I learned I couldn’t really do it the way I’d originally planned. That contribution represents <1% of his IRA balance and only a prorated amount of withdrawals he makes each year will be tax- free. In other words, we can’t just do a one-time withdrawal of $6500 (tax-free) and call it a day. Obviously I knew we’d be subject to taxes on withdrawals from his IRA, but I thought we could get that contribution in a lump sum fashion. Lesson learned. Thankfully it wasn’t that much and only happened one year.

[RedmondStash]

I don’t think RedmondStash is talking selling and buying both within the IRA. I think he is saying selling taxable and within 30 days buying the same fund within his IRA.

Yep. Also, not he, she. Or they would be fine too. :)

Interesting. Let's say you want to sell shares of an IRA fund and buy shares of the identical fund within the 30-61 day period.  For example, you sell 5k in shares in Jan. to reduce taxable income of previous year AND buy 5-10k of identical shares within the same IRA acct.......within 30-61 days - if you don't care about writing off potential losses associated with the sale, is there any penalty/rule for this situation or even the reverse (buy $5-10k and then sell $5k)?

Since you're talking about waiting more than 30 days, I don't think the wash sale rule applies.

Generally the advice given in these situations is to buy something else. So if you sell Total Stock Market, buy S&P 500. They're similar but not identical enough to trigger a wash sale.

But -- I also don't think selling in January would affect the previous year's taxes.

[jeroly]

I don’t think RedmondStash is talking selling and buying both within the IRA. I think he is saying selling taxable and within 30 days buying the same fund within his IRA.

Yep. Also, not he, she. Or they would be fine too. :)

Interesting. Let's say you want to sell shares of an IRA fund and buy shares of the identical fund within the 30-61 day period.  For example, you sell 5k in shares in Jan. to reduce taxable income of previous year AND buy 5-10k of identical shares within the same IRA acct.......within 30-61 days - if you don't care about writing off potential losses associated with the sale, is there any penalty/rule for this situation or even the reverse (buy $5-10k and then sell $5k)?

Since you're talking about waiting more than 30 days, I don't think the wash sale rule applies.

Generally the advice given in these situations is to buy something else. So if you sell Total Stock Market, buy S&P 500. They're similar but not identical enough to trigger a wash sale.

But -- I also don't think selling in January would affect the previous year's taxes.

The wash sale rules do not apply to sales/purchases made entirely in an IRA only - there are no capital losses that would be involved in the initial sale.

[iluvzbeach]

I don’t think RedmondStash is talking selling and buying both within the IRA. I think he is saying selling taxable and within 30 days buying the same fund within his IRA.

Yep. Also, not he, she. Or they would be fine too. :)

My apologies…I started to word it in a non-gender specific way but somehow had in my head that you were male and that I was okay in that regard.

[RedmondStash]

I don’t think RedmondStash is talking selling and buying both within the IRA. I think he is saying selling taxable and within 30 days buying the same fund within his IRA.

Yep. Also, not he, she. Or they would be fine too. :)

My apologies…I started to word it in a non-gender specific way but somehow had in my head that you were male and that I was okay in that regard.

No biggie.

[bmjohnson35]

I never started any Roth IRA's. I now realize this was short sided on my part and it will restrict us going forward. A ladder conversation doesn't work with our existing financial situation. 

I used my 401k as my main retirement investment vehicle over the years.  I didn't pay attention to the fact that investing in an IRA requires you to have traditional income during the year.  Now that I'm retired, this requirement is impacting us.  If it wasn't for the spouse's pt job, we wouldn't even be able to place any funds into an IRA to reduce our AGI. Not a huge deal, but I should have known this.

I should have become more familiar with tax rules much earlier in life. No serious gotchas yet, but it has and will make things a little bumpier.

When I reluctantly accepted a transfer out of state, We bought a house almost immediately.  Due to various factor's, we ended up moving back to our previous state.  We couldn't sell the house and ended up leasing it for awhile, but ultimately ended up selling it at a $50k loss.  In hindsight, we should have rented the first year instead of buying immediately.

When we were shopping for our retirement home, I had a set budget and planned to pay cash.  We bought a townhouse that met our overall needs and within budget, but spouse is not happy here.  If we had spent another $30-60k, we could have bought a single family home spouse would have been happy with and we would be set for many years.  We will eventually sell and buy something else at a higher cost.  Budgets are fine, but beware of tunnel vision with major long-term purchases. 

[nouseforausername]

@bmjohnson35 -- great points!

As for me, I never even knew what a Wash Loss deferred was until I accidently triggered one when I was in my early or mid 20s.

Same with S Corp. / Schedule K taxation treatment of certain stocks (MLPs, etc). I had no idea what they were until I got the tax forms the following spring.

Also, tax planning generally -- the use of 529s and other ways to take the edge off of taxation when needed. I live in a state that curtails above the line deductions starting at an AGI of 100k. For a year or two, I needlessly fell above that line by a tiny amount that I could've easily have planned away.

Also, ditto on buying a townhouse when I should've just skipped ahead to a single family home. Also -- just for me personally -- insisting on buying a fixer upper and spending all that time and $ on skills I really dont need seems foolish. Not saying DIY is bad, just saying I could've spent a modest amount more on a fully finished single family home back when I bought.

DIY for the sake of DIY / valuing my $ over my time. Meh. I wish I would've known that sooner, but no worries.

[Rubic]

Both of my gotcha's apply to retiring in Europe from the US.

My first minor gotcha is that most non-US countries don't recognize the tax-free
status of Roth IRA withdrawals. Since I'll be moving to Europe next year, this affects
my strategy for Roth conversions.

The second gotcha is a high capital gains tax on sales of equities, even though they're
sourced in the US.

It's not a big deal for me, since I have assets spread across multiple buckets, but it
changes my tax planning considerably for the next 5-6 years.

[dandarc]

I have one to add. DH retired six years ago and was no longer able to contribute to a 401K, so we started maxing out an IRA contribution for him and we’d do it in January each year (you know, invest early & often, yada yada.) Well, my income increased one year to the point that his IRA contribution was no longer deductible. I stupidly didn’t bother to do a back door Roth conversion for these funds and just left them in his IRA thinking we’d be able to take the full amount of the contributed funds out at some point tax free. This is the year I decided we’d take those funds out and in conducting research I learned I couldn’t really do it the way I’d originally planned. That contribution represents <1% of his IRA balance and only a prorated amount of withdrawals he makes each year will be tax- free. In other words, we can’t just do a one-time withdrawal of $6500 (tax-free) and call it a day. Obviously I knew we’d be subject to taxes on withdrawals from his IRA, but I thought we could get that contribution in a lump sum fashion. Lesson learned. Thankfully it wasn’t that much and only happened one year.

At < 1% of total I'd be tempted to just lose track and pay tax on the full amount of any withdrawal.

I ran into one with a soloK - account gets large enough and you have to file 5500EZ every year. Simple enough and can even be done online now. Except that the IRS' system is really built for CPA firms that have lots of people doing returns like this for lots of businesses - there's more review / sign / approve steps that might seem necessary at first because of that. So this July, I thought I had filed the 5500-ez, but all I had done was sign it. Then I forgot about it until a moment of panic in October when I thought I hadn't done this form at all (so brief it is fogettable), logged in to find the error and then made my big mistake - I submitted the form immediately. Penalty for late filing is $250 per day up to $150,000 max- Even though I caught the issue early, I had unwittingly racked up a $19,500 late fee for this form for which no tax is ever due. Just an information return.

What you should actually do if you make this error and catch it yourself - file a paper return along with the self-reporting program form on late filing, which limits your cost to a much more reasonable $500 per return, capped at $1500 total if you file 3 or more returns late for the same plan and submit at the same time. Of course, this voluntary program is only available <before> you submit the return. So I messed up by failing to click the last button in July, and messed up again by clicking it in October.

I'm told "you know, I tried and just made an error on that last step to submit the thing" might be accepted as reasonable cause and I might get out of this for $0. But "might" and "have to wait likely several months for a decision" means $500 is a heck of a deal to me even though it is > $0.

[iluvzbeach]

Dandarc, yes, our plan is just to forget the contribution and pay taxes as we go. Not worth tracking it each year.

For the record, reading about your potential $19,500 mistake makes me feel much better about mine. I hope you can get an exception made for waiver of the penalties.

[lutorm]

Both of my gotcha's apply to retiring in Europe from the US.

My first minor gotcha is that most non-US countries don't recognize the tax-free
state of Roth IRA withdrawals. Since I'll be moving to Europe next year, this affects
my strategy for Roth conversions.

The second gotcha is a high capital gains tax on sales of equities, even though they're
sourced in the US.

It's not a big deal for me, since I have assets spread across multiple buckets, but it
changes my tax planning considerably for the next 5-6 years.

We're in a similar situation, and I was wondering whether it would make sense to harvest all the unrealized gains before making the move.

As far as US-expat gotchas, there are many others. One particular that I've learned that applies to Sweden is that rolling over a 401k into an IRA has been deemed to be a taxable event by the Swedish tax authorities, so we definitely have to accomplish that before the move.

[lutorm]

One gotcha that I thankfully learned before it could bite me was the tax treatment of ISO (Incentive stock options): Exercising an ISO does not result in any taxable income in the normal tax system, but the difference between the fair market value at the time of exercise and the option strike price counts as income for AMT purposes. This means that if you are offered ISOs and exercise them after a substantial gain, you can be subject to an essentially unlimited tax hit without having any cash to pay it with.

Example: You're offered 10,000 options at a strike price of $1. 5 years later, the stock price is now $100 and you exercise your options. To exercise this, you have to pay $10,000, nbd. However, you have just realized $1 million of AMT income. This  instantly catapults you into AMT territory and you will have a tax bill of ~$260,000 come tax time. Since your stock may not be liquid, or may lose value, this can screw you over massively.

[ATtiny85]

The IRA pro-rata rules. The impact of our large rollover IRAs on our ability to tax-efficiently get more money into Roth accounts has been annoying. Since we will be leaving decently early, we will be able to convert a lot at decently low costs in a few years, but I lament a bit at the yearly contributions we have missed out on.

And of course the simple math of the impact of fees. Never even suspected anything back in the beginning.

[Rubic]

I've thought of another gotcha which can creep up on you, especially if you start
your investments early in your career:

Required Minimum Distributions  (RMDs)

When I first set up my IRA account -- long before Senator Roth established the Roth IRA which
bears his name -- I was vaguely aware that I would eventually be paying taxes on my withdrawals.
But all the financial advisers assured us that we would be in lower tax brackets in our retirement
years.  This is pretty much true for the population as a whole.

The gotcha is the RMDs. With the compounding effect of funds in my IRA, I could be forced
to withdraw far more funds than I will need, pushing me into an even higher marginal tax bracket.
I've executed some Roth conversions over the past few years and will start to withdraw funds
from my IRA before the RMDs kick in at age 72 -- even though I may not need them.

I should point out that this is a high quality problem to have, so I'm not complaining. However I
consider this a gotcha because when you're younger you may think "well, that's something that
I can deal with when I'm in my 70's"  Less than 10% of retirees will be affected by RMDs, but I
expect that percentage will be higher for Mustachians.

There's currently legislation for the SECURE 2.0 Act which will further mitigate the effect of
RMDs, by gradually raising the RMD age from 72 to 75.

[swashbucklinstache]

Target date funds can force large taxable events outside of your control and should not be held in unsheltered taxable brokerage accounts.

[RWD]

Target date funds can force large taxable events outside of your control and should not be held in unsheltered taxable brokerage accounts.

There was a whole thread on this one, I had no idea prior to that.
https://forum.mrmoneymustache.com/investor-alley/crazy-high-capital-gains-on-vanguard-target-date-funds/

[seattlecyclone]

Target date funds can force large taxable events outside of your control and should not be held in unsheltered taxable brokerage accounts.

This is not something special about target date funds. Any mutual fund that has significant redemptions can be forced to realize gains and distribute those gains to the remaining shareholders.

[wenchsenior]

Target date funds can force large taxable events outside of your control and should not be held in unsheltered taxable brokerage accounts.

Yup. I wasn't prepared for this.

Then I spent much of the first 3 months of year trying to decide if I should transfer funds and take another tax  hit. In the end I decided no, I'll just take the occasional tax hit and invest in a 3 fund portfolio for my slush fund going forward.

Glad I learned this lesson when my total affected cash was less than 200K, though.

[RedmondStash]

These are great. I had no idea that withdrawals from a Roth IRA could be a taxable event in a country outside the U.S. Live and learn.

Keep 'em coming!

[ender]

Friend of mine got screwed cashing out savings bonds for EITC.

The investment income cap there is really, really low.

[ca-rn]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

Interesting. Let's say you want to sell shares of an IRA fund and buy shares of the identical fund within the 30-61 day period.  For example, you sell 5k in shares in Jan. to reduce taxable income of previous year AND buy 5-10k of identical shares within the same IRA acct.......within 30-61 days - if you don't care about writing off potential losses associated with the sale, is there any penalty/rule for this situation or even the reverse (buy $5-10k and then sell $5k)?

An easy way to avoid a potential wash sale is to keep separate funds, either totally different sectors or different brokerage etfs.  I have total world in my rothIRA and international/some other international/total stock/500 s+p, large cap for tlh. 

[rantk81]

NIIT surtax above 250K
Medicare surtax above 250K

[mizzourah2006]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

A simple way around this is to have different funds for different accounts. So use VTI for one and VOO for another, etc.

[ATtiny85]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

A simple way around this is to have different funds for different accounts. So use VTI for one and VOO for another, etc.

Yeah, but this might breakdown a bit when trying to keep the number of TLH partners in check. If you constrain yourself to not holding VOO in the taxable account that is all VTI, what fund would you use to TLH? There are others of course, but VTI and VOO are really good partners for TLH.

[mizzourah2006]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

A simple way around this is to have different funds for different accounts. So use VTI for one and VOO for another, etc.

Yeah, but this might breakdown a bit when trying to keep the number of TLH partners in check. If you constrain yourself to not holding VOO in the taxable account that is all VTI, what fund would you use to TLH? There are others of course, but VTI and VOO are really good partners for TLH.

That's a good callout. Could you use a Russell 1k fund for TLH? Something like VTI to FSPGX and VOO for IRA. Or any combination of that?

[bacchi]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

A simple way around this is to have different funds for different accounts. So use VTI for one and VOO for another, etc.

Yeah, but this might breakdown a bit when trying to keep the number of TLH partners in check. If you constrain yourself to not holding VOO in the taxable account that is all VTI, what fund would you use to TLH? There are others of course, but VTI and VOO are really good partners for TLH.

That's a good callout. Could you use a Russell 1k fund for TLH? Something like VTI to FSPGX and VOO for IRA. Or any combination of that?

FZROX works if you're at Fidelity. It's a TSM fund that uses a proprietary index.

[RedmondStash]

I thought it might be useful to start a thread sharing things we've learned along the way that surprised us. Maybe we can help each other not repeat our own mistakes.

I just recently learned that selling an asset at a loss in a taxable account, and then buying that same asset within 30 days in an IRA, can trigger a wash sale. I'd always figured that what happened in IRAs stayed in IRAs, because all the assets are taxable when withdrawn (distributed) from the account -- or in the case of Roth IRAs, none of them are. I knew about wash sales, but it didn't occur to me that purchases in an IRA could be included.

What have you learned that surprised you, good or bad?

A simple way around this is to have different funds for different accounts. So use VTI for one and VOO for another, etc.

Yeah, but this might breakdown a bit when trying to keep the number of TLH partners in check. If you constrain yourself to not holding VOO in the taxable account that is all VTI, what fund would you use to TLH? There are others of course, but VTI and VOO are really good partners for TLH.

That's a good callout. Could you use a Russell 1k fund for TLH? Something like VTI to FSPGX and VOO for IRA. Or any combination of that?

FZROX works if you're at Fidelity. It's a TSM fund that uses a proprietary index.

You could also swap into something somewhat less related for 30 days, like VIGAX or VFTAX, and then swap back into the original fund (VTSAX or VFIAX). More bookkeeping, but I doubt one month in a less related fund would make much long-term difference.