How To Make Money With Zero Capital

I have a problem and it is Facebook. No, I don't check it 500 times per day. The problem is that the stock is eating my portfolio:

On The Hook With Facebook

In May of 2012, I bought 1,000 shares of Facebook when it went public at about $41. And then it dropped, so I bought more. And then it continued to drop, so I continued to add to my position. When the dust had settled, I had bought another 1,000 shares and brought my cost basis down to about $30.

Here are some of the shares in my ETRADE account. The second category from the right shows total gain percentage.

My hypothesis was simple; I thought that Facebook would smoothly move to mobile (it was a desktop experience in 2012) and that the service would be successfully monetized. Both happened and the stock now sits at around $190. I've since sold 550 shares, but still hold 1450 or about $275,000.

Facebook is, by far the largest investment I own. And it terrifies me. Facebook is a social network and at some point, users will get bored and move on to something else. I don't want to be caught holding the Facebag. However, big tax bills also terrify me. But, I figured out a way out of it.

How To Pay Zero Capital Gains

For the early retiree, long-term capital gains may not be an issue. This is because you pay $0 in federal taxes if your taxable income plus your capital gains are under a certain threshold. For a married couple, it's $77,200 and for a single person, it's $38,600:

So, let's say you're married, earn$50,000/year and have $20,000 in long-term capital gains; you pay $0 in taxes for the stock sale.

#winning

However, my personal situation is a little different. Mrs. 1500 has her dream job and occasionally this blog spits out little chunks of money. While our income is variable, I think that we'll earn more than $77,200 this year. At first glance, it looks like we're liable for long-term capital gains. Upon deeper investigation, I found a way to avoid Mr. Taxman for most of my gains.

Standard Deduction Seduction!

To start, let's assume that Mrs. 1500 and I make $90,000 this year. The new tax law gives us a standard deduction of $24,000, reducing our taxable income to $66,000. We're now $11,200 below the capital gains threshold:

$77,200 – $66,000 = $11,200

I'm currently sitting on $232,000 in capital gains, so $11,200 doesn't amount to much. At that rate, assuming all variables stay the same, it would take 20 years to sell all of it.

Standard deductions are seductive and sexy, but not overwhelmingly so. Kinda like your favorite supermodel when you were a teenager, but now you're 35 and they're 45. They still look good, but it will never be the same.

Hold on, the numbers get better! (However, the post doesn't. It's all downhill from here.)

401(k) To The Rescue!

I love 401(k)s almost as much as I love my wife, children and plastic dinosaurs.

I said "almost!" Mrs. 1500, please know that by "almost," I mean that I love you at least twice as much as my 401(k). And I definitely love you more than I love the dinosaurs. Seriously.

"Ever heard of John Wayne Bobbitt? I'll bet he loved 401(k)s too!"

Ummmmmmmmmmm…

Anyway, Mrs. 1500 has a 401(k) at her job and I have a self-directed 401(k) for my corporation. The 2018 limit for 401(k) contributions is $18,500 per person. Remember that this money comes out pre-tax. In other (and beautiful) words, it reduces taxable income. If Mrs. 1500 and I both max out 401(k)s, we've reduced taxable income by another $37,000. So, let's add this to the calculation:

$90,000 (income) – $24,000 (standard deduction) – $37,000 (401(k)) = $29,000 (!!!)

We've reduced our taxable income from $90,000 all the way down to $29,000. Let's revisit the capital gains calculation again:

$77,200 (upper 0% limit) – $29,000 (our taxable income) = $48,200

We can now take $48,200 in long-term capital gains and pay $0 in federal taxes. Amazing, right? Super-sexy even!

But it gets even better.

Upping The Cost Basis!

Let's say you have a stock calledDinosaurs 'R Us(ticker: $DRU) that's appreciated a ton, but you want to hold on to it. If you can perform the hack described above to keep federal capital gains at $0, it may be worth selling $DRU and immediately repurchasing it. Why? It raises your cost basis, minimizing capital gains down the road.

Amazing!

This strategy is useful if you anticipate increasing income in future years. This is a real possibility for those of us who have fat 401(k) balances. For a detailed explanation of the strategy, see Michael Kitces' excellent piece on Capital Gains Harvesting.

The Caveats

So, there is one big and one small caveat to this hackery:

The big one is state income tax. For example, my home state of Colorado charges taxes on long-term capital gains regardless of taxable income. It is low (< 5%), but it's still there.

The other caveat is that you may just be deferring a tax bill. 401(k) withdrawals are taxed as ordinary income. Again, if you have loads of money in a 401(k), you could be hit with a required minimum distribution later in life.

Check your own state laws and your accountant to be sure of this hackery before you attempt it. I'm just a weirdo on the internet who plays with plastic dinosaurs. What could possibly go wrong?

I'm Totally Doing This (and Maybe A Tattoo Too)

While I will have to pay state income tax, I'm taking advantage of this hack to start unloading my Facebook. Mrs. 1500 and I are maxing out our 401(k)s so we can maximize the selling. I didn't need another reason to love 401(k)s, but now I have one.

Mrs. 1500 keeps asking me if I'll get a tattoo (she has several) (none of my likeness) (none of the dinosaurs either). I've always said:

NO!

But now, I'm reconsidering. I'm sure that Mrs. 1500 wants me to get a tattoo that reflects our relationship and our children, so she may be dismayed when I show up with this one instead:

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