(click on the topic to fast forward there)

1. Intro/Recap

2. Level 3: Charitable Giving

3. Level 4: Life Changes (Live in a low-tax state, Get Married, Real Estate)

4. Level 5: Playing with the Big Boys

5. Conclusion

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Introduction

Welcome Back to Part 2!

To recap: If you are a high earner, taxes will be the largest line item of your lifetime expenses. High W-2 earners are also the most heavily taxed, with the most restrictions on the deductions they can take, the timing of those deductions, how they’re taxed, etc etc.

However, there are still ways to plan your taxes efficiently & minimize the amount you pay now and over your lifetime. In Part 1, we talked about thinking about it like a pyramid:

We started from the very basics that everybody should be doing (Level 1 - maximizing employer-sponsored retirement plans & leveraging employee benefits) before moving to Level 2 (making the way you invest that money as tax-efficient as possible).

In this final Part 2, we’ll cover the last 3 levels of the pyramid.

Level 3: Charitable Giving

Standard Deduction & Itemized Deductions

On your tax return, you can either take the standard deduction ($32,200 for married couples filing jointly in 2026) or itemize your deductions.

If you take the standard deduction, starting this year you can deduct up to $1,000 ($2,000 if filing jointly) of qualifying cash charitable contributions.

If you itemize your deductions, you have more leg room, but there are still important limits. One key rule is that you can generally only deduct the portion of your charitable contributions that exceeds 0.5% of your adjusted gross income.

There are also limits on your overall deduction depending on what you donate, the type of charity you donate to & how the charity uses the donation.

As always, there are documentation/substantiation, recordkeeping and reporting requirements, so make sure you keep proper records.

Tithing/Donating Cash to Charity

The simplest method of charitable giving is to simply donate cash directly to a public charity or church.

Your tithes & offerings to churches, mosques, and other qualifying religious organizations count. Just make sure the organization is a qualified charity. (Under IRS rules, churches in the U.S. are automatically considered qualified 501(c)(3) public charities.)

Important Note: performing services or volunteering your time doesn’t count as a charitable deduction.

Donate Highly Appreciated Securities (Instead of Selling Them)

Last year, Google co-founder Sergey Brin gave away $700 million worth of Alphabet shares. This year, SpaceX President & COO Gwynne Shotwell and her husband announced a donation of roughly $325 million in SpaceX stock to the new Trump Accounts program.

One of the best tax strategies is to donate highly appreciated stock or other securities instead of selling them first and donating the cash. Not only do you avoid paying capital gains tax on the appreciation, but you also receive a charitable deduction for the full fair market value of the donated shares. It doesn’t mean you should sell for the sake of it, but if you were already going to sell/cash in stock that have greatly appreciated in value (very high capital gains tax), it gives you a double benefit while you do.

REAL-LIFE EXAMPLE:

Imagine you bought 1,000 ABC shares at $100 per share (a total investment of $100,000). Over the years, the stock skyrockets to $1,000 per share (so your total holdings are now worth $1,000,000).

This strategy can also apply to private company stock and digital assets like Bitcoin.

Donor-Advised Funds (DAFs)

DAFs are special charitable accounts that help reduce a lot of the admin headache of charitable giving.

How it works: A 3rd party sponsor manages the account. You simply contribute assets, receive the tax deduction immediately, then the sponsor decide sover time which charities should receive grants from the fund (with your advisory). The benefit is that you can get the dedcuction today even though the actual charitable transfer can be made later.

There are minimum contribution requirements with some providers & once you contribute assets to a DAF, you cannot change your mind and move the money back into your personal account. Remember, you’ve effectively made an irrevocable charitable donation.

Charitable Trusts & Private Foundations

The highest level of charitable tax planning is setting up a charitable trust or a private foundation.

Biggest downside is that they are significantly more expensive to establish & maintain. However, they can be extremely effective especially for estate tax planning because charitable contributions are one of the major exemption to federal estate tax.

On paper, donating assets to your own private foundation can sound like a “tax hack”, like you’re giving money to yourself. But in reality, there are many extensive IRS rules around self-dealing, distributions, governance, and other restrictions that make operating a private foundation much more complex than it can seem.

Level 4: Life Changes

Levels 1-3 have mainly been about moving money around & optimizing your investment portfolio. This next level is a step up because it involves decisions that affect you as a person and your family.

For these decisions, taxes should not be the only (or even the primary) reason for doing them. Always run the numbers first.

Live in a Low- or No-Tax State

There are currently 9 states in the U.S. with no state income tax on W-2 salary (federal taxes always apply). The most popular for young to middle-aged professionals are Florida, Texas, Washington and Tennessee.

On paper, moving to one of these states automatically lowers your overall tax bill if a salary is your primary source of income.

Even outside those states, moving from a high-income tax state like California (13.3%) or New York (10.9%) to a lower-tax state like Pennsylvania (3.07%) or Ohio (2.75%) can also reduce your taxes.

But again, that’s on paper.

As a recent Bloomberg article highlighted, the cost of living can actually be higher in lower-tax states.

For example, Miami, Florida (which has no state income tax) is apparently now more expensive to live in than New York City, one of the highest-tax states in the country.

Income tax is important, but it’s only one part of the larger picture of your life.

Get Married

These Federal income tax brackets for 2026:

As you can see, filing jointly as a married couple widens the tax brackets compared to filing as a single person with the same total income.

For example, if you have $300,000 of taxable income & your boyfriend/girlfriend has $100,000, your marginal tax rate as a single filer would be 35%. But if you were both married and filed jointly, your joint marginal rate would be 24% - a difference of over 10 percentage points.

This “Marriage Boost” works best when there’s an income disparity (1 spouse earns significantly more than the other).

If both spouses earn roughly the same amount, the benefit is much smaller. For example, if both you & your spouse earn $300,000 (total $600,000), you’re still in the 35% marginal bracket as joint filers, just as you would have been individually.

At certain income levels, there can even be a “Marriage Penalty.” If you study the tax bracket chart carefully, you’ll notice that married couples can pay more tax than 2 comparable single filers when each spouse’s individual income falls roughly between $384,351 and $640,601.

For dual high-income earners, this is definitely an area where tax planning matters.

On the flip side, there are opportunities too. Our next newsletter will cover how to leverage this during periods when one spouse continues working while the other starts a business or ventures outside corporate/traditional employment.

A rarely discussed benefit for immigrants is that a U.S. resident (citizen or green card holder) who is married to a non resident alien (for example, someone on a student visa) can elect to treat their spouse as a U.S. resident for tax purposes.

This can be beneficial because it allows you to claim the standard deduction, something non-resident aliens ordinarily cannot do.

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Own Your Own Home

Most tax deductions can only be taken for business or investment expenses, not personal expenses. One of the rare exceptions to that is owning your own home.

Your mortgage payment has 4 main components:

• Principal

• Interest

• Property taxes

• Insurance

Of these four, interest and property taxes can be deducted for federal income taxes if you itemize your deductions.

Keep in mind that you have to itemize for these deductions to actually benefit you. (i.e your total itemized deductions should exceed the standard deduction for the year).

Interest:

Interest on up to $750,000 of mortgage debt is generally deductible. Interest on home equity loans is also deductible if the funds are used to buy, build, or substantially improve your home (may be worth using a dedicated account so you can clearly show how the funds were used).

Note: The $750,000 limit is a total cap per taxpayer (or married couple), not per home.

Property Taxes:

You can deduct state & local property taxes you pay, up to $40,400. It’s a particularly good time to take advantage of this because the deduction limit is scheduled to drop back to $10,000 in 2030.

Gain on Sale Exclusion:

When you sell your primary residence, you can exclude up to $250,000 of capital gains from tax ($500,000 if married filing jointly). To qualify, you must have owned & lived in the home as your primary residence for at least 2 of the 5 years before the sale.

This is especially important for people planning to leave the U.S (you’ll want to complete the sale before you’ve been away long enough to lose eligibility for this benefit).

Foreign Property Taxes:

The other rules above can still apply if your home is outside the U.S., but you generally cannot deduct foreign real estate taxes paid on a personal residence.

Rental Property

This is different from owning your own home for personal use. Here, you’re owning real estate for business or investment purposes.

Real estate alone could have its own 2-part newsletter, so we’ll just focus on the strategies that can directly offset active W-2 salary or wage income, since those are much fewer.

Short-Term Rentals (STRs)

By default, the IRS classifies all standard long-term residential rental activities as passive. That means any losses or deductions can generally only offset other passive income & you can’t use them to lower your active W-2 tax bill.

One exception is a short-term rental. A property is generally not considered a “rental activity” under the tax rules if the average guest stay is 7 days or less (provided you can document and support this).

Another requirement is that you must prove material participation. There are several ways to do this, but a common way is by logging at least 100 hours of work on the property yourself + working more hours than anyone else involved (such as a property manager or cleaner).

This area is heavily audited because the IRS knows people are chasing these tax benefits, so careful documentation really matters.

As you can tell, this starts looking like a full-time job of its own, that’s why it’s a Level 4 strategy.

Cost Segregation + Bonus Depreciation

Normally, a residential rental property is depreciated over 27.5 years.

With a cost segregation study, a certified professional separates the property into different components, some of which can be depreciated over much shorter time periods (especially things like appliances, carpeting, flooring, lighting, etc).

Bonus depreciation may then allow you to deduct a large percent of those shorter-life assets in Year 1 instead of spreading the deductions over many years.

Combined with the short-term rental strategy, the large upfront depreciation generated through cost segregation & bonus depreciation can significantly offset your ordinary W-2 or business income. It’s possible to offset $50,000–$100,000+ of active income at once this way.

You’ll want professionals involved from the very beginning, especially for the cost seg study.

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Real Estate Professional Status (REPS)

Remember the rule that rental activity is passive by default? Short-term rentals are one exception. Another is if you or your spouse qualifies for Real Estate Professional Status, which allows qualifying rental real estate losses to be treated as non-passive.

To qualify, you generally have to pass 3 tests:

1. 50% Test: More than 50% of the total hours you work across all jobs or trades during the year must be in a real estate trade or business. Realistically, that means you generally can’t have a separate full-time, non-real-estate career.

2. 750 Hours Test: You must spend over 750 hours working in real estate during the year, with detailed records & time logs.

3. Material Participation: As discussed earlier with short-term rentals.

If it’s the right fit & executed well, this strategy can be extremely valuable and potentially offset your active W-2 income.

But I’ll be real with you, it’s rarely the right fit for most W-2 salary earners, and it’s even rarer to see it executed well. It’s one of the most challenged areas for individual taxpayers by the IRS, and case after case after case shows that it’s nowhere near as straightforward as people online make it sound.

For a W-2 earner, the 50% test is the hardest bar to clear.

Let’s say a standard 9-to-5 work year is 1,920 hours (8 hours a day, 5 days a week, 48 weeks per year, allowing for paid time off and public holidays). To clear the 50% test, you’d need to spend at least 1,921 hours working in real estate.

That’s roughly 37 hours every week, on top of your day job. That’s hardly realistic, even before thinking of how it’ll be documented correctly.

For most W-2 employees, a more realistic path is having a spouse who already works in real estate (ideal) or one who doesn’t have another full-time job (less ideal).

A stay-at-home spouse is the example people usually give to satisfy these tests, but personally, I’ve never really seen that play out in real life. Someone who wants to stay home & handle the household (or not work at all) usually doesn’t also want to spend 750+ hours a year working on real estate if they didnt already work in real estate or have the interest to. Like I’ve never seen or heard of that.

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Level 5: Playing with the Big Boys

We made it. You have now reached is the very top of the pyramid when it comes to income tax strategies, both in terms of complexity & potential tax savings.

They’re few & far between and the best kind of candidates for these strategies are people who experience a sudden, significant windfall.

Qualified Opportunity Zones

Qualified Opportunity Zones (QOZs) are areas designated by the government for economic development & job creation.

Under the program, you can defer paying capital gains tax if you re-invest the gains within 180 days into a qualified fund that invests in QOZs.

If you hold that investment for at least 10 years, any appreciation on the Opportunity Zone investment itself can be sold free of federal capital gains tax.

Nonresidents and foreigners can also benefit from this program. But to be honest, the capital gains exclusion is the main attraction. Many of the underlying investment opportunities themselves aren’t always that compelling.

Oil & Gas

Certain investments in U.S. oil and gas activities can provide significant tax benefits.

The main one is that some losses can be treated as active (can offset W-2 income) without you having to qualify as a real estate professional.

An example is Intangible Drilling Costs. This lets you deduct roughly 80-85% of your investment immediately in Year 1.

While this can be a fantastic strategy, be aware of the downsides.

From an investment standpoint, these projects are highly risky & often difficult to sell or liquidate. Unlike real estate, which typically grows in value over time, an oil well is a depleting asset that eventually reaches a value of zero. Investing only or solely for the sake (or hope?) of tax savings is a red flag. If you’re going to do this it should be because the investments terms and returns are attractive to you & taxes are just a sweetner not the motivation.

The tax reporting side of it can also be a headache. It’s common to receive K-1s and have filing obligations across multiple states where the drilling activities take place.

Conclusion

This isn’t to say there are no other tax strategies out there. There are certainly more niche ones (especially around tax-efficient investing), but the ones we’ve covered in Part 1 & 2 are the major ones that most W-2 earners should know.

In summary:

• Yes, W-2 earners are more limited in their tax planning options, but they’re also incredibly fortunate to have high, stable income that can be planned around. America is one of the few countries where you can start from nothing, build a valuable skill set, land a high-paying job & realistically become a millionaire and move into the upper middle class. All without necessarily taking extraordinary risks or doing anything drastic. You’re in a better position than most human beings at any time or place have ever been.
  

• The tax code, in its modern form, has existed for almost 90 years. If there’s a true “loophole,” you can bet it’s either extremely difficult to access (& comes with its own costs and trade-offs) or it’s not really a loophole at all, but an intentional incentive created by Congress or the IRS to encourage certain behaviors.
  

• The best way to think about tax planning is as a pyramid. Before jumping on the next shiny strategy, make sure you’ve covered the fundamentals first, then work your way up from there. Don’t add complexity before there’s a need for it.

Ultimately, the best tax planning is one that’s tailored to your own personal situation. Planning that fits things you were already going to do anyway, timed correctly, so they naturally work with your life, and not ones that force you to squeeze your life around the tax code.

If you’d like to discuss what this could look like for you or build a personalized tax and financial plan, we’d be happy to help. You can get in touch here: https://www.arushawealth.com/contact

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In 2019, he ran for President of Nigeria under the YPP banner.

In our conversation, Kingsley shared:

• Growing up in a war-torn Biafra

• His years at the UN and why he ultimately walked away from the international civil service

• Reforming Nigeria’s Central Bank as its Deputy Governor

• Running for President of Nigeria in 2019 and why Nigeria isn’t a democracy

• How the diaspora can move beyond remittances into real investment

• Notes on life, regrets and legacy

Watch the full conversation here:

Table of Contents

1. Intro

2. Level 1: The Basics

   1. Maximize Employer-Sponsored Retirement Plans

   2. Understand and Leverage Employee Benefits

   3. If You’re Living Abroad

3. Level 2: Tax-Efficient Investing

   1. Asset Location

   2. Municipal Bonds and U.S. Treasuries

   3. Tax-Loss Harvesting

   4. Direct Indexing

   5. Tax-Aware Long-Short Investing

   6. Investment Interest Expense Deduction

Introduction

In 2025, Jeff Bezos received $81,840 in salary from Amazon but he sold roughly $5.7 billion of Amazon stock.

Most of us know that salaried employees (W-2 employees) generally seem to pay more in taxes than business owners, even when both are earning active income. But very few people understand why or how.

At Arusha Wealth, we see many high earners want to jump straight into complex tax planning strategies without first getting the basics right. They’re looking for the next “tax hack” or “loophole” while overlooking simple opportunities that could meaningfully reduce their tax bill.

Part of the reason is that most people don’t have an intuitive understanding of how the tax code works.

But once you understand the logic behind the tax code, even without memorizing any laws, you can easily tell the difference between sensible tax planning, exaggeration/puffery that’s ‘too good to be true’ & planning that’s legitimate but likely costs more than it saves.

To draw this mental model clearly, this series is organized into 5 levels of tax planning for W-2 employees. Think of it like a pyramid.

Each level builds on the previous one & introduces strategies that are generally more complex, involve greater tradeoffs, or apply to a narrower group of people.

In Part 1, we’ll cover Levels 1 & 2. Level 1 focuses on the foundational tax-saving opportunities that every W-2 employee should understand, while Level 2 goes deeper on the tax-efficient ways to invest. In Part 2, we’ll move up the pyramid to Levels 3 through 5, where the potential tax savings become much larger, but so do the complexity, costs & tradeoffs.

One important note: this series focuses primarily on federal income taxes. It does not cover state income taxes, or estate and gift tax planning, which are separate topics with their own set of rules.

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Level 1: The Basics

Level 1 is about making full use of the tax-advantaged accounts and benefits that are already available to you. For most W-2 employees, these should be the first opportunities to maximize before considering more advanced tax planning strategies.

Maximize Employer-Sponsored Retirement Plans

Max out your 401(k) or 403(b)

• 2026 employee contribution limit: $24,500

• If your employer offers a matching contribution, contribute enough to receive the full match. It’s one of the few times you’ll get an immediate, risk-free return on your money

457(b) Plans

• If you work for a government employer or certain nonprofits, you may also have access to a 457(b)

• One of its biggest advantages is that it has a separate contribution limit from your 401(k), allowing you to save significantly more on a tax-deferred basis

Check if your employer offers a true-up provision

If you front-load your 401(k) and stop contributing midway through the year, your employer may also stop matching your contributions. A true-up provision fixes this by calculating what you should have received over the full year and depositing any remaining employer match after year-end.

Max out your Health Savings Account (HSA)

An HSA is one of the most tax-efficient accounts available.

• 2026 contribution limits: $4,400 (self-only) and $8,750 (family coverage)

• You can contribute through payroll deductions or directly from your bank account. Payroll contributions are generally more tax-efficient because they also avoid payroll taxes (more about that below)1.

• You must be enrolled in a High Deductible Health Plan (HDHP), which isn’t the right choice for everyone. Make sure it fits your healthcare & family needs first.

Max out your Traditional or Roth IRA

• 2026 contribution limit: $7,500

• You can contribute to an IRA for a child who has earned income (not investment income)

• A non-working (stay-at-home) spouse can also be eligible through a spousal IRA

• Above certain income limits2, you can no longer contribute directly to a Roth IRA, but you may still be able to use a Backdoor Roth

Backdoor Roth

A Backdoor Roth involves making a non-deductible contribution to a Traditional IRA & then converting those funds into a Roth IRA.

The strategy allows higher-income earners who exceed the Roth IRA income limits to access the benefits of Roth accounts, where future qualified growth and withdrawals are tax-free.

There are important technical rules to be aware of, such as the pro-rata rule if you already own pre-tax IRAs & proper tax reporting, so this strategy should be implemented carefully.

Mega Backdoor Roth

This is like the older brother of the Backdoor Roth.

It works through your employer’s 401(k). You first make after-tax contributions to your 401(k), then you convert those funds to a Roth IRA or Roth 401(k).

The biggest advantage is that it allows you to move substantially more money into Roth accounts each year, in some cases up to an additional $47,500 depending on your employer’s matching contributions and plan design.

Not every employer-sponsored 401(k) supports this strategy, so check with your benefits plan, Human Resources, or plan administrator.

Roth Conversions During Lower-Income Years

A Roth conversion often makes the most sense when your taxable income is temporarily lower than usual.

Examples include:

• layoffs

• career breaks

• the 1st year of starting a new business

• the period between when withdrawals from retirement plans are allowed (age 59.5) & when they’re compulsory (age 73-75) and before claiming Social Security (the most popular time for Roth conversions)

Another opportunity is during a market downturn. If your retirement account temporarily falls in value, you can convert the same number of shares while recognizing a lower dollar amount as taxable income. If the market later recovers, that future growth happens inside the Roth account.

Deferred Compensation

Some employers offer nonqualified deferred compensation plans that allow highly compensated employees to postpone receiving part of their salary until a future date.

Unlike a 401(k), there is generally no legal contribution limit. The amount you can defer depends on your employer’s plan. A well-known example is Shohei Ohtani, who deferred $680 million of his contract with the Los Angeles Dodgers.

The tradeoff is that these plans carry more risk than a traditional 401(k). The money remains an obligation of your employer rather than being held in a protected retirement account. If the company becomes insolvent, creditors may have a claim on those assets.

Understand and Leverage Employee Benefits

To understand why employee benefits are so valuable for taxes, it helps to know that there are 2 separate taxes on your salary:

1. Federal income tax: This is the tax you file a Form 1040 for every year. Your tax rate depends on your total taxable income from all sources (salary, capital gains, interest, dividends, etc.) Federal marginal tax rates currently range from 10% to 37%

2. FICA tax (Social Security and Medicare): This is a separate payroll tax that funds Social Security and Medicare. You don’t file a separate return for it. Instead, it’s automatically withheld from each paycheck at a flat rate of 7.65% (6.2% for Social Security & 1.45% for Medicare)

The distinction is important because the opportunities to reduce these 2 taxes are very different.

There are many ways to reduce your federal income tax. FICA taxes, on the other hand, are much more difficult to reduce. For most W-2 employees, one of the only ways to lower FICA taxes is by receiving certain forms of compensation as tax-favored employee benefits, also known as fringe benefits.

These are benefits provided in addition to your salary that the Tax Code specifically exempts from FICA taxes.

Some of the most valuable examples include:

• Employer-sponsored health insurance: Your share of medical, dental, vision, and certain other insurance premiums is generally deducted before both federal income and FICA taxes.

• Health Savings Accounts (HSAs): Like we discussed above, payroll HSA contributions reduce both federal income tax & FICA tax. (If you contribute directly from your bank account instead, you generally don’t receive the FICA tax savings)

• Flexible Spending Accounts (FSAs): This includes Healthcare FSAs for eligible medical expenses & Dependent Care FSAs for qualifying childcare or eldercare expenses.

• Commuter and transit benefits: Pre-tax payroll deductions for public transit & qualified parking expenses.

A good place to start is your employee benefits guide. Take some time to review the benefits your employer offers & identify anything you’re not using or don’t fully understand.

Many people are leaving money on the table simply because they never enrolled in benefits they were already entitled to. Because fringe benefits are one of the few legitimate ways W-2 employees can reduce FICA taxes, it makes no sense to not take full advantage of them when you can.

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If You’re Living Abroad

If you’re a US citizen or permanent resident living & working abroad, there are 3 major tax provisions that can significantly reduce your U.S. tax bill, especially if you’re living in a low-tax jurisdiction:

Foreign Earned Income Exclusion

This allows you to exclude up to $132,900 of earned income per person (not investment income) from U.S. federal income tax.

Foreign Housing Exclusion

The Foreign Housing Exclusion allows you to exclude or deduct certain reasonable housing expenses paid by your employer, including rent, utilities, property insurance.

Foreign Tax Credit

With this, you can claim a credit for income taxes paid to a foreign country, to prevent double taxation on the same income.

For many Americans employed abroad, these three benefits are the foundation of tax planning. Which one, or combination, makes the most sense depends on your income, where you live & the tax rules of that country.

Level 2: Tax-Efficient Investing

Once you’ve handled the basics, the next level is making sure you’re investing in the most tax-efficient way possible.

Some of these strategies can technically be done yourself, but in practice they’re very manual, time-consuming, operationally complex & easy to get wrong and report wrongly for taxes. That’s why they’re often implemented through advisors & managed investment accounts. Since those accounts come with management fees, it usually makes sense to master Level 1 first before paying for more advanced optimization.

Asset Location

Most people are familiar with Asset Allocation, which is deciding what to invest in (stocks, bonds, real estate, crypto, etc.)

Asset Location is deciding where to hold those investments.

For example:

• High-growth stocks may be better suited for a Roth IRA, where they can grow tax-free & future growth can be withdrawn tax-free

• High-yield bonds are often better held in a traditional 401(k), where regular interest income is sheltered from current taxation

• Crypto (or other volatile type of investments) may be better held in a taxable brokerage account, where losses can potentially be harvested to offset future gains

Choosing the right account for each asset can meaningfully improve your after-tax returns over time without changing what you actually invest in.

Municipal Bonds and U.S. Treasuries

Interest earned from municipal bonds is generally exempt from federal income tax. If you buy municipal bonds issued by your own state or local government, the interest is often exempt from state & local income taxes as well.

This has made municipal bonds very useful for our clients in high-tax states like California & New York.

Keep in mind that this tax benefit applies to the interest income, not any capital gain you realize if you later sell the bond.

U.S. Treasuries (bills, notes, bonds) work differently. Their interest is still subject to federal income tax but is exempt from state & local income taxes.

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Tax-Loss Harvesting

There are 2 main types of tax losses:

1. Ordinary losses, which generally arise from businesses

2. Capital losses, which arise from selling investments for less than you paid

For W-2 employees, ordinary losses are relatively uncommon & even harder to intentionally create or time. Capital losses, on the other hand, are largely within your control because you decide when to sell your own investment.

Tax-loss harvesting is the process of intentionally realizing capital losses by selling investments that have declined in value. Those losses can then be used to offset capital gains & reduce your overall tax liability.

Capital losses can offset an unlimited amount of capital gains. If losses exceed gains, you can use up to $3,000 each year to reduce your ordinary taxable income. Any unused losses carry forward indefinitely to future tax years.

2 important rules to remember:

1. Tax-loss harvesting only works for investments held in taxable brokerage accounts, not tax-advantaged accounts like 401(k)s or IRAs

2. Be mindful of the wash sale rule, which generally disallows the loss if you buy the same or a substantially identical investment within 30 days before or after the sale

Direct Indexing

This is like a super-charged version of tax-loss harvesting.

Instead of buying 1 S&P 500 ETF, you directly own the 500 individual stocks that make up the index in a taxable account.

This allows you to harvest losses on individual stocks throughout the year while keeping the overall portfolio closely aligned with the index. Stocks sold at a loss are then replaced with similar investments to maintain the same market exposure while avoiding the wash sale rule.

Because this process involves managing hundreds of individual securities & frequent trading, it is typically handled through specialized software and managed accounts.

Many brokerages require a minimum investment of around $100,000 before offering direct indexing, along with ongoing management fees.

Tax-Aware Long-Short Investing

Tax-aware long-short investing takes things another step further.

After Direct Indexing for a while, you begin to notice that there are not many stocks in the portfolio that are losing value enough to sell to keep offsetting gains, especially if in a bull market.

A tax-aware long-short strategy addresses this by using leverage to buy stocks expected to rise (longs) while simultaneously short-selling stocks expected to fall (shorts). The losses generated from the short positions can help offset taxable gains elsewhere in the portfolio, even when the general market is rising.

The goal is for the tax savings to outweigh the investment losses while still producing a positive overall return.

These strategies are generally designed for high-net-worth investors. Minimum investments often start around $1 million, and come with high investment fees + margin interest on the borrowed leverage.

Investment Interest Expense Deduction

If you borrow money to purchase investments that generate taxable investment income, the IRS can allow you to deduct the interest you pay on that borrowing.

The deduction is limited to your net investment income for the year.

For example, if you paid $5,000 in margin interest but had only $2,000 of net investment income, your deduction for that year would be limited to $2,000. Any unused amount may generally be carried forward.

There are also a few important limitations. You must itemize deductions to claim this benefit (not take the standard deduction) & it doesn’t apply to interest on mortgages, personal loans, credit cards, or money borrowed to purchase tax-exempt municipal bonds.

That wraps up Part 1 of this series.

In Part 2, we’ll cover Levels 3 through 5, where the potential tax savings become much larger, but so do the complexity, costs & tradeoffs.

We’ll look at topics like charitable giving strategies, the numbers behind major life decisions that are often said to save taxes (like moving to a low-tax state, getting married, buying a home, or investing in real estate). We’ll also examine some of the strategies at the very top of the tax planning pyramid, including Opportunity Zones and oil and gas investments, and discuss when they actually make sense.

If you’d like to discuss your specific situation or build a personalized tax and financial plan, we’d be happy to help. You can get in touch here: https://www.arushawealth.com/contact

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