In today’s episode, we’re tackling these topics:
🧠 Understand how TALS generate real tax alpha
💼 When the strategy is best used and when it’s not
📉 Pairing with trader fund structure = business losses
❌ Why most CPAs and advisors miss this
💬 Real-world examples and implementation tips
Listen Now:
The Smart Take:
Over the past month, we released a six-part video series breaking down how ultra-wealthy investors think about taxes, and more importantly, how they legally minimize them.
In this episode, we’ve stitched the entire Tax-Aware, Long-Short (TALS™) Strategy /series together to allow you to hear the full framework in one place, and we’re making it our year-end podcast episode. We’ll talk about why traditional tax strategies fall short for high earners, how advanced tax-aware investing actually works, and the investment structures that have historically been reserved for ultra-high-net-worth families but are now becoming accessible to more investors.
If you want to see the charts, visuals, and examples that go along with this discussion, you can watch the full six-part video series on YouTube.
Learn more about the Retire Smarter Solution ™: https://www.truewealthdesign.com/ep-45-retire-smarter-solution/
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Walter Storholt: If you’re a high earner, an investor, or someone who’s tired of watching taxes quietly eat away at your returns, this episode is for you. Welcome to a special edition of Retire Smarter. I’m um, Walter Storholt and over the past month we released a six part video series breaking down how ultra wealthy investors think about taxes and more importantly how they legally minimize them. In this episode we’ve stitched that entire series together for those of you who like to consume our content in audio form and we’re making it our year end podcast episode. This will allow you to hear the full framework in one place. We’ll talk about why traditional tax strategies fall short for high earners, how advanced tax aware investing actually works, and the investment structures that have historically been reserved for ultra high net worth families but are now becoming accessible to more investors. If you want to see the charts, visuals and examples that go along with this discussion, you can certainly watch the full six part video series on YouTube. That link is in the description. Certified financial planner and wealth advisor Kevin Krosky will be our guide through this series. Let’s start by answering a simple but important question. What exactly is tax Aware long short or TALS for short?
Kevin Kroskey:
Hi, I am Kevin Kroskey. I’m the founder and CEO of True Wealth Design. We are an award-winning wealth management firm, USA Today Best Financial Advisers 2024/2025, headquartered in Northeast Ohio, serving clients throughout the country. And we have a wealth firm, but we also have a tax and accounting division. We’re a team of 24, and we really focus on integrating these two aspects to make sure everything is aligned to support you and make the most out of what you have. Today we’re going to talk about TALS, the tax efficient investing strategy formerly reserved for ultra-high net worth clients, and today, becoming more accessible to qualified but broader groups of clients and investors. Bloomberg broke an article on this in October of ’24, and it says, “Wall Street takes tax-loss harvesting to a new level.” So you can look up the article.
So when we talk about the new approach, it’s been around for a while, but this application of it, it’s evolved like many things do in the world. And the new benefits from a tax perspective are really astounding. And so, what TALS means is tax-aware long-short. I know it’s a mouthful, that’s why we use TALS. Tax-aware means we’re going to be very tax aware in how we’re going to trade, and we’re going to seek to go ahead and produce tax benefits. Long-short is an investing strategy that’s been around for decades. It too has evolved, but if you do long-short investing and search that, typically you’re going to find what the strategy really was historically. It still exists today. It’s typically been the realm of more hedge funds where they want to go ahead and short companies that they don’t like and go long companies that they do. Classic example that I use is going short Pepsi and going long Coke, but that gives you an idea. But historically, it’s been very concentrated.
So TALS is not that. It’s really taken a much broader approach from an investing standpoint, and inevitably, you’re going to have one core thing that’s going to come down and really make this work. So one principle, if you will, and it’s inherent in the stock market, it’s not a loophole in the tax code or anything like that. It’s the simple fact of how stocks behave and how a group of stocks behave. A group of stocks, say like the S&P 500, have a certain level of volatility. How much they go up and down over a course of the year is a common measurement, and that is typically about 15 or 20%. It evolves over time. Markets are different of course, but an individual stock within the S&P 500 tends to be two to three times, maybe even four times as volatile, and it depends on the stock. So there’s something that we call the wiggle factor. The wiggle factor.
We’ve mentioned that many times over the years through our Retire Smarter Podcast and these videos, and essentially, that wiggle factor for the individual stocks are a lot more than a group of stocks. And so, sort of a more recent evolution has been into direct indexing where it’s just that. Say, “Hey, we want S&P 500 exposure. Rather than buying an ETF or mutual fund that provides that, we’re going to go ahead and buy either all of the 500 individual stocks or a representative sample to go ahead and get that exposure.” And we can use that volatility of the individual stocks to our advantage. Why? Because on any given year, many of the stocks within the S&P 500 or whatever index we’re pursuing for that matter, are going to go down. A lot of the winners are concentrated in terms of a few high performing stocks. It’s just how the distribution of these returns work in the market.
So even though we can expect positive returns over time from the stock market, at least on a historical basis, when you break down the composition of those individual securities within the stock market, call it the S&P 500 for this purpose, a lot of those stocks are going to go down. And so, when you have that volatility, you can actually overlay a very tax aware, smart trading algorithm to go ahead and harvest those losses. This has been done in direct indexing for many years. However, stocks do tend to go up over time. So the lost harvesting abilities tend to decline. In fact, studies show that while, if you do a cash investment in direct indexing in year one, maybe as much as 17% in net capital losses could be realized in that first year. It dissipates quite quickly, and when you get out to about year 10, you’re talking maybe 1, 2, 3, maybe 4%.
To put that in concrete dollar terms, if we’re talking about a million dollar account, freshly invested cash, maybe you sold a house or sold a business, what you can have there in say, year one, direct indexing 17%, potentially $170,000 in net capital losses. All the while, hypothetically, if the S&P 500 went up by 10%, you still capture that return. So again, the goal of any investment profile is to increase the wealth over time. Again, there’s all kinds of other things that are attached to that, but when we talk about losses, we are most definitely not talking about losing money. I like to reframe it and call it creating a tax asset. So again, if the S&P 500 goes up close to its historical average, say around 10%, year one direct indexing, cash invested, maybe $170,000 in net capital losses. But as we get out to year 10, maybe the account has grown over time.
Maybe that million dollar account has all been reinvested and now we’re at, say, five million, but now we’re talking about maybe just 2% or so in net capital losses to be harvested. Again, we haven’t put any new money into it. So these stocks have grown over time, and their cost basis stays the same while they continue to appreciate building these unrealized capital gains. So at that point in time, year 10, direct indexing, you’re talking only about five million, 2%. That’s not a lot of money per year in terms of concrete dollars that you’re going ahead and harvesting. So the long-short part of TALS, again, tax-aware, but now long-short. When we’re adding in the short component, we can go ahead and still track S&P 500 like returns if that’s our intention. There’s maybe other ways we want to do it as well, but because we’re adding in the short component, there’s always going to be something that’s winning and always something that’s losing in the portfolio.
Now it really unleashes and opens up the opportunity to harvest many more losses while we’re pursuing our wealth creation goals. And in terms of percentage terms, what we see here in year one, cash invested, maybe a 30% lost realization rate. It could be higher. So now we’re talking about almost 2x what direct indexing does in year one. In year 10, we can see it typically being close to about 10% and being able to sustain that over time. So it does not decline as close to zero as direct indexing does. So if we’re talking about, again, $5 million, say in year 10 with our growth, our unrealized capital gains, we’re talking about $500,000 in net capital losses in year 10 for the long-short TALS strategy. Again, for direct indexing, we’re not talking about 500,000. We’re talking about something closer to maybe about 100,000 or so.
Again, unleashing the opportunity to be more tax aware, to harvest more net capital losses at the same time that we’re pursuing these wealth creation goals.
So capital gains taxes, what are they? Well, whenever you sell something, you sell a home, you have a potential capital gains tax, you sell a rental property, you sell some sort of property, and that could produce a capital gain. What we’re generally talking about are capital gains on investment sales.
So if you sell a mutual fund, you sell an ETF, those sorts of things that we have there. You could also sell a business can often produce very sizable capital gains if you were successful there. So when we think of avoiding capital gains taxes legally, what’s the best way to do that? Easy, we don’t sell anything. I’m joking, of course. If you didn’t sell your investments from time to time, it would be like a bush that gets out of control. You need to prune it. You need to make sure that you keep your portfolio, keep your strategy on track. So not realizing gains is not a good sound strategy, but we want to be smart about it. One of the things that I want to start with is what a lot of people they kind of know, but they kind of forget about until they get a surprise with a 1099.
And what we’re going to pivot to and what I’m going to share with you are just some capital gain distribution estimates from a popular mutual fund family. And when you take a look at the screen here, you can see the fund name on the left and then you’ll see a percentage range of what the payout is going to be. Now they’re short term, there’s long term, those describe the type of taxation that the distribution is going to have, and then it gives a dollar amount as well. So most people that have had mutual funds have had certain years where they’ve had a big surprise and they get the 1099 and even though they didn’t sell anything, some gains were distributed to them. And this is really because of the buying and selling at the mutual fund level. So if you have losses in the mutual fund, they don’t distribute those to you.
That’s something, this is one thing that a lot of people, financial people included generally don’t understand. Any losses, sure they can offset gains, but they’re trapped at the mutual fund level. The gains, however, because you have people that are entering or exiting the fund, you have the fund managers that are doing trading within the fund as well, those gains can be distributed. So certain years, people may be thinking like, “Yeah, hey, I remember getting hit by that.” What you can see here, you’ll just point out a couple, but for the first fund that’s listed there, the long-term percentage is three to 6%. So let’s put this in dollar terms. If you have $100,000 holding in this mutual fund, they’re saying about 3,000 to $6,000 of gains are going to be distributed to you. So even if you don’t sell it, when that distribution happens, they’re going to go ahead and pay out the cash.
It depends on your settings for the mutual fund, whether you’re going ahead and reinvest that and that reinvestment would increase your cost basis or whether you’re going to receive that dividend in cash and then may be more thoughtfully go ahead and reinvest it as you continue to prune your investment portfolio. I’ll take a quick scroll down here, but you can see here that as you can get into some of maybe the more common names with what you’re familiar with, one, the Growth Fund of America, candidly, is still a fund that we see a lot in people’s portfolios. They’ve owned it for a long time. It did particularly well throughout the 2000s, and it has a lot of embedded, AKA unrealized, gains. Maybe people are a little leery of selling it for just tax reasons, for example. Here you can see the Growth Fund of America is going to distribute between eight and 10% this year in 2025.
So again, if $100,000 investment, that’s going to be 8,000 to $10,000 even if you hold onto it and do nothing. So be mindful of that for one. Now, while we’ve talked a little bit about mutual funds, we’re going to go ahead and pivot and talk about maybe something that’s more commonly owned these days. Maybe not more commonly, but certainly more dollars flowing into these assets. And those are exchange traded funds or ETFs. Now, ETFs, they don’t have to worry about the flows coming in and out of the fund in the same way that mutual funds do and so they can actually follow what’s called an in-kind redemption process. I know it sounds wonky, we won’t get into those details, but following that allows the fund manager to not have to go ahead and realize these gains and distribute them to the ETF shareholders. So that’s important.
There’s also been a more recent innovation and a lot of our clients have these mutual funds that were great or still good, and they basically are replicating the benefits of the ETFs. So they’re following a similar in-kind redemption process and they’re going ahead and limiting and potentially even eliminating the gains that are being distributed. Not all fund families are doing that, similar to what you saw when we share the slide previously. So those are two things. The structure matters here. And again, we’re not just going to not sell and let the tax tail wag the dog. You always want to focus on not only optimizing your pre-tax returns, but then also your after-tax returns. So then if we talked about mutual funds, if we talked about ETFs, again, stocks are similar too to ETFs. They’re not necessarily going to distribute a gain until you sell it.
They certainly may kick off a dividend whether it’s qualified or non-qualified to different types of taxation there. But one of the things that we often do here at True Wealth and we’ve been educating about is something called TALS. And that’s tax-aware long-short. And we’ve done other videos on this, you can refer back to them. But really what this does in its essence is continues to pursue these pre-tax returns, seeks to improve the diversification in fact. And in so doing, because there’s a long and short component, there’s always something that’s going to be down in the portfolio and that can be harvested in a tax smart trading manner to go ahead and realize those losses. So how do we go ahead and legally avoid capital gains tax? Well, if we have some losses to offset our gains, those two net out when we complete our 1040 tax return, and perhaps you can completely eliminate them.
So be sure to check out our TALS videos. Again, tax-aware long-short strategy. It’s a newer innovation. The long-short investing strategy is something in and of itself, it’s been around for a long time. It’s certainly evolved and continues to evolve in a favorable manner. But now you put those two together and you do it with a tax smart way and you have to have somebody that’s really familiar, not only with the investment component, but with the tax component. And if you can do that, then you can really pursue not only those higher pre-tax returns, but you can also pursue significantly higher after-tax returns. And that latter part is something that’s much more controllable over trying to predict what the market’s going to do.
So what is long-short equity investing? You may not have heard of this before. Long-short investing has been more in the domain of hedge funds for the last 20 or 30 years. It did involve into mutual funds, particularly say after the 2010s. There was a lot of funds called 13030 funds. And I’ll kind of show you an example of what that is exactly if we peak under the hood. But tax-aware long-short investing combines the long-short component with more improved diversification, simply going long and short more stocks. And it’s also going to have a very favorable tax trading algorithm overlaid on it to pursue some after tax benefits.
So let’s go ahead and let’s take a look. So I have up on the screen here a certain mutual fund that we don’t have to get into the fund, but we’re peering under the hood here. So if we look at the asset allocation of the fund, you’ll see here there’s a net, a short, and a long. What you can see for the equity category is there’s almost 194% long equity in the portfolio and there’s about 178% that’s short equity in the portfolio. When you net the two, it’s certainly far from being all equity. You can see here it’s only about 16%. The fund name actually has market neutral in the name. So what market neutral means is it’s trying not to have any correlation, any sort of co-movement with the public equity market, with global equities. And in fact, if we come over here to this other criteria on the screen, this alternative style, you can see global equity correlation.
So this is global stocks, not just US, but global stocks around the world, which US currently is about 65% in terms of market capitalization for that. But there’s actually a negative correlation that’s there. You can see minus 0.18. So it’s negative beta, fancy word. I shouldn’t have even mentioned it, but it’s not correlated to stocks. So in a portfolio, it’s good to have some things that behave differently. And of course, they need to have positive expected returns. So you may have bonds in the portfolio, you may have stocks in the portfolio. You may have a market neutral, long, short strategy like this. Now, if we think about what this means historically, when we think about long, short investing, it was much more concentrated. It was basically making company specific bets about like, “Hey, this company is going to outperform that company. So I’m going to go long Coke and I’m going to short Pepsi.” So you take away some of the industry risk, if you will, but it’s only two stocks.
It’s making a very concentrated, not diversified bet. That has been traditionally the realm of these hedge funds. What we’re doing in the tax aware long, short environment is making a much, much bigger bet. Now, we say bet, we’re investing strategically. It’s not really like we’re betting, but essentially we’re spreading our risk over many, many more stocks. It’s not uncommon to see a portfolio, a TALS portfolio, tax aware, long short portfolio, having maybe as many as 2,000 stocks within it, depending on the size of it. So those stocks could have 1,200 that are long, maybe 800 that are short, and you’re really kind of going with that market neutral approach. You can also have stock market exposure in there that’s basically called having positive beta. If you want to pursue global equities or US equities or US small equities, you can really have some flexibility in how you’re implementing it.
But there’s two key differences that I would point to. The long, short investing of yesteryear, it’s still out there, but frankly, with our investment philosophy and with what the data shows, it just doesn’t work. It’s not a reliable source of expected return. You’re making concentrated bets and typically you do not get compensated for risks that can be diversified. That’s been an investing role that’s been around for more than 50 years now. In the tax aware environment that we’re talking about with this more quantitative approach to it rather than a certain stock-based approach to it, here we’re going long and short a basket of stocks. So it could be a bunch of quality stocks. What does that mean? It could means that they have high levels of profitability. They have high cash flows. They have low debt levels. They have high ROE, more kind of a technical term that you’ll see on some screens like Morningstar that we were looking at earlier.
And what’s opposite of quality? Well, academics had a sense of humor. They call it junk. And what this factor is called, if you will, this investing component is quality minus junk. And that’s simply kind of the opposing trades. Those are stocks with low levels of profitability, high debt levels, low cash flow. All those things kind of comprise a junky stock, if you will. So QMJ, quality minus junk. That’s just one example of a certain factor that we would go ahead and pursue in this TALS framework. But wait, there’s more. And what’s more is really kind of the tax aware nature of it all. So in terms of being tax aware, you have to go out of a mutual fund format because any losses that are realized get trapped there. But when you do that, we can implement that through whether it’s a separately managed account.
We own the individual equities. And when we do that, and because we’re investing in a long and short environment, something will always be going up and something will always be going down in the portfolio. So that gives you much, much more losses to harvest and offset any capital gains that you may have. These capital losses can be used to offset capital gains, not only from your investment portfolio, they can be used to offset gains from a business sale. They can also be used strategically in a more sophisticated limited partnership investment where you could potentially go ahead and offset ordinary income.
Yes, that’s right. Ordinary income, the highest tax rate that’s out there. So this is what tax aware long short investing is at its core. It’s using a very good investing process, investing philosophy to go ahead and pursue a better diversified portfolio to add some additional excess return to your pre-tax returns, but then really focus on the tax aware nature and harvest the ability to go ahead and sell losers that are down and replace it with something that’s similar, maintaining the investment strategy and going ahead and realizing some tax benefits to significantly improve those after tax returns.
It could be used in many different ways. If you’re a concentrated stock, perhaps you’re an executive at a company, perhaps you inherited some low basis assets from a family member or through a trust. Perhaps you were just very good or maybe even lucky with making your own investment and you saw certain stocks soar over the last decade or two and you have a very large unrealized capital gain. We need to prune the portfolio. We need to trim the bushes to keep the landscaping looking good. We need to do the same with our investment portfolio. You need to pay attention to the gains that are going to be realized, but you don’t want to let the tax tail wag the dog. The tax strategy will allow you to go ahead and pursue both pre-tax returns, more diversification and heightened after tax returns by implementing this new age, long, short strategy in a very tax thoughtful manner.
So who wins? It’s TALS every time. Sure, there’s some complexities, but that’s what somebody like a good advisor can help you manage. There’s other ways that maybe you could do it on a DIY basis, but this is something that you really need to understand and be careful with on how you implement.
So tax loss harvesting, I think most of you know what it is. You may go ahead and look at your portfolio. If something is down, you sell it, you realize the loss and you go ahead and buy something that is not identical, but similar so you maintain your investment strategy. So that’s pretty basic stuff.
Now, there’s some devil in the details that there seems to always be, but I can tell you from experience in running a wealth management firm for more than 20 years now, that how you execute this can be very difficult. You have to be looking at the portfolio constantly. You have to have technology set up where you can really manage this and look and identify positions that not only are down, but positions that are good replacements and also that they’re down by a certain dollar amount of percent. You don’t want to be too active in your trading because there are some frictional costs of trading. And certainly if you have a preferred holding, it’s preferred for reasons. So you may not just want to sell it if there’s a small loss.
So there’s going to be some certain thresholds. I can tell you during peaks of volatility, like we had extremely during COVID that we had in 2022, even, that we even had in April of 2025 after Liberation Day. Those days are very difficult to trade because the ups and the downs are quite severe. So there’s definitely a lot more to it than just selling something when it comes down to it. And if you’re not looking, if, maybe, you’re only doing it monthly or quarterly or annually, well, ultimately, you’re going to miss out on some of those potential benefits. So that’s tax loss harvesting.
Now, some of the benefits that you can realize that from a tax perspective, certainly if you realize a loss, it can offset a capital gain. We do this all the time proactively. Even as long as we have a good substitute for a holding in the portfolio, we will be happy to harvest losses for clients if it meets our certain thresholds to go ahead and make it worthwhile. That allows us to also use those losses to offset maybe other gains, not only that the client has, but perhaps we want to go ahead and realize as we continue to maintain their portfolio strategy and keep it in line with where we prefer to be.
Said another way, for example, US equities have done incredibly well over the last couple of decades. A lot of clients certainly have had the price appreciation in those US equities. We do need to go ahead and sell things that are high and buy things that are low. Those are rule number one when it comes to investing. Buy low, sell high. But when you’re working in a taxable environment, when you have a brokerage account, when you’re getting a 1099, you have to be mindful of the tax implications in doing it. You don’t want to be stubborn about it, candidly. Sometimes people have these biases where it’s like, “Man, I really don’t want to pay the tax. I’m not going to sell.” That’s not a good solution, either.
So what is a good solution? Well, sure. Again, this tax loss harvesting is the basics. It’s not so basic given how you really need to operate it to go ahead and get the benefits how they could be. But assume that you are or assume that your advisor is on your behalf. Well, what’s next? There’s other things that you can do for sure. There’s things that like, “Hey, we could go ahead and move into an ETF rather than a mutual fund to avoid some capital gain distributions.” We’ve talked about this in a prior video. Sure, we can go ahead and look at maybe there’s something called exchange funds, which we won’t get into, but could be useful for the right person. There’s something called a 351 exchange. This is a way to go ahead and take an undiversified position and potentially tag on to an ETF launch and seek very tax efficient, broad diversification. There’s many ways to do it.
One of our favorite ways to do this is through something that we call TALS. That stands for Tax Aware Long Short Investing. There’s a fair amount of complexities to this, but let me give you a high level. If you take a look at the visual here, you can see basically in a long-only portfolio, you have those investments. Long only means you’re just buying the S&P 500 or you’re buying a group of stocks or group of ETFs, whatever it may be. You’re not shorting anything. Shorting sounds weird in some ways, may sound unfamiliar. That’s okay. But it’s been around for, candidly, hundreds of years. It’s really important to how the market functions, but for say retail investors, for clients like ours that we serve, it tends to be an unfamiliar strategy.
Here, what we’re talking about doing is a very quantitative, very process driven way to go ahead and pursue pre-tax returns, more diversification, but also really create tax assets through strategic harvesting of losses. And when you have a short component to the portfolio and a long component, that means something is always going up and something is always going down. We have maybe 2,000 stocks in this sort of strategy. So that’s a lot of stocks. And again, in the down market, hey, you’re going to have some shorts that are probably making money. Stocks do tend to go up over time, which is a really good thing for all of us, in terms of creating wealth. And so you’re going to have that environment, as well. But if we’re going to do it in a very tax smart manner, while we are adhering to sound investment processes and principles, here we can really create these tax assets by harvesting net capital losses on a consistent basis.
Stocks are volatile. Markets move up and down. The broad stock market will move up and down about 15 to 20%. It’s annualized volatility. If you break it into its component pieces, the individual stock volatility is two, three, maybe even four times that for certain stocks. Harvesting that volatility in a very tax smart, prudent investing way is what we’re talking about here with TALS. So when you go into this overlay, if you will, this is a long, short. You see the light blue, 30% long, 30% short, doesn’t take more than, I don’t know, third grade math to know that plus 30 minus 30 is going to net out to zero, so we’re not necessarily adding risk here, not adding equity risk. We’re adding diversification a different source of return. And when we do so, again, because something will always be going up and something will always be going down and we can overlay that tax smart trading algorithm to the strategy, we can consistently harvest these losses.
So now we’re not just talking about, “Hey, we can maybe harvest losses in a down market.” Here we’re talking about we can literally harvest losses pretty consistently month in and month out throughout the course of the year and throughout an investor’s lifetime. So if you’re having capital gains problems, if you have unrealized capital gains, if your portfolio’s out of balance, if you have these low basis stocks that maybe you accumulated, being a company executive, having stock option grants, having restricted stock vest and appreciate over time, if you’ve made some good investments yourself, maybe you’ve owned Nvidia for many years or Microsoft forever, you get the idea. You can have a very large and significant unrealized gain. Going beyond the traditional tax loss harvesting can really open the door for more opportunities here. We call it TALS, Tax Aware Long, Short investing strategy. It’s a game changer. We really moved our business in this way and we think you should seriously consider it, too.
We’ve all heard it, right? Hey, save. Put the money in the 401(k). Go ahead and out of sight, out of mind. Pay yourself first, maybe even. You put more money into these 401(k) accounts. You go ahead and get the tax break up front. The money grows, and then it comes out and it’s going to be fully taxable. You’re supposed to be in a lower tax bracket in retirement. That’s at least what we all thought. Nobody knows what future tax rates are. We’re not going to pretend that we know that. However, I think we’re all aware that our country is in a little bit of debt. Today we have some of the lowest tax rates that we’ve had in the country for forever, for that matter, at least since we’ve had the tax code more fully developed over the last several decades.
What we found in serving our clients over the last 20-plus years is that maybe that traditional wisdom just didn’t work. They saved, they invested, they put the money in the 401(k), they got the employer match. That’s great, but then they kept moving up the ladder. They kept making more money, putting more money into the 401(k). Maybe they had a pretty benefit-rich plan and the employer put a fair amount in too. Over time, what they found is maybe they ended up with more than they expected. Great problem to have, but it also can create an unintended tax consequence.
Here they are, they have a lot of money in these 401(k) accounts yet to be taxed. They got a little tax break on the seed. The crops and the harvest grew, and now when they’re bringing the money in and out, maybe because they’re in retirement or because they have to through required minimum distributions, now it’s being taxed maybe at a similar or even higher rate. IRMAA sound familiar? That Medicare adjustment that goes ahead and adds dollars to your Medicare premiums once you’re in retirement?
Now, that’s another way we can think of that as a tax rate too. You take your base tax rate, you go ahead and you take any other tax rates that are being added onto it. You could have something called the NIIT, the net investment income tax. You could go ahead and have these Medicare surtaxes as well through IRMAA. Basically it equates to about another four to five percent on your marginal tax rate. It’s quite easy for successful retirees to find themselves in a higher bracket, so what do we do?
There’s a lot of things that you can do while you’re still working. Sure, there may be Roth IRAs. There could be backdoor Roth IRAs. There could be mega backdoor Roth IRAs. You could save tax efficiently into a brokerage account. One of the things that we’re big believers in here, and we think is an absolute game changer for our clients, is following something called tax-aware long-short investing. We call it TALS for short. Yes, it’s a mouthful. That’s why we say TALS. What TALS allows you to do is strategically create tax assets by being very smart in how you’re implementing your investment strategy and how you’re trading it. Tax-aware long-short.
Long-short is the investing strategy. We have other videos that delve into those details, but because it’s long and short, it allows you to be more tax-aware. Something is always going to be going up, something is always going to be going down. Here we can go ahead and have the very prudent investing process, seek to actually enhance our pretax returns, improve our diversification, and be tax-aware to create these tax assets to create and harvest these net capital losses from the portfolio.
They can be significant. If we have a million dollars of cash, maybe we sold a business, maybe we sold a house, maybe we inherited some money. Going into a TALS strategy could allow you to have 30% in net capital losses in year one in a base strategy. It could even be more if we got into higher dollar amounts or took more leverage.
Say our strategy is to follow the S&P 500. We want to achieve S&P 500-like returns. We can do that with TALS, implement it in a long-short framework. The benefit is, because we are owning individual stocks and we have them both long and short, we can continue to harvest tax losses from this, creating tax assets that can be valuable, and offset capital gains income and even ordinary income elsewhere on your tax return. We can have a good, sound investing process. We can seek to go ahead and achieve those S&P 500 or whatever benchmark returns, we can seek to improve the diversification, but we can create these tax assets on top of it.
If we have large unrealized capital gains, sure, we can go ahead and offset those. Those losses will net out against the gains, and maybe you can completely avoid the capital gains tax. These could be things like on a business sale, or on a concentrated stock that you should diversify. It could be on a multitude of things, but wait, there’s more, as they say on the infomercials on TV.
What’s more is you can take another level of sophistication. You do have to be an SEC qualified purchaser. That means you need to have about $5 million in liquid investments. I know it’s pretty rarefied air, but there’ll be several people that are listening to this, and we serve several of those clients, where if you are in that rarefied air, creating these tax assets through the net capital losses can help you here too by offsetting some capital gains that a limited partnership investment may kick off, and also that would leave you with business losses.
It’s a unique structure, but structure and strategy both matter. It’s not just a strategy, it’s the execution of it. When you get into these more advanced structures for SEC qualified purchasers, there’s just the normal tax rules that work here, but it’s a very smart utilization of some underlying strategies and specific products within these structures, that can go ahead and kick off short-term capital gains that can be offset by these tax assets we’re creating elsewhere in your portfolio, with you being left with business losses.
If you have a large K-1 income, you can actually offset that K-1 income with this investment strategy, potentially saving you six or even seven figures in taxes per year. It can offset non-business income too, subject to limitations. For a married couple in 2025, that’s $626,000 of non-business income. Things like wages, bonuses, interest, non-qualified dividends, royalties. There’s a lot of things that we pay at these higher ordinary income rates that a TALS strategy, implemented in the right way with enough liquidity, can create significant after-tax improvement to your investment results.
It’s TALS. It’s a mouthful. It’s tax-aware long-short investing. Structure matters, strategy matters. It’s a game changer for our clients here at True Wealth, and maybe something that you should consider too.
So the title is definitely a little bit marketing foo foo, right? Hey, the ultra wealthy, the secrets. I didn’t write it. My marketing professional did, but here’s what I’m going to share with you. It’s significant, it’s substantial, it exists. You can do this through custodians such as Schwab and Fidelity, so it’s passed their due diligence. Otherwise, they would not be holding these sorts of investments that can produce these sorts of results. So of course, disclaimers are going to be there. Consult your tax advisor, consult your attorney, what have you, or give us a call and we take on that liability because we stand behind our work.
But what are we really referring to here? On many of our prior episodes, we’ve talked about TALS, tax-aware long-short investing. Long-short is the investing component. The tax-aware is really how it is executed from a trading strategy to produce tax assets. I’m not going to go over those details in this video. You can see our other content related to it.
But here what I’m going to focus on is suppose that we’ve been using TALS. We’ve created these tax assets, these net capital losses through a good sound investing process and a tax-aware trading strategy that goes ahead and produces these tax assets for us. We’ve accumulated them. Now, what are we going to do with them? Well, here’s where we’re going to get into something for the SEC qualified purchasers. Those are people with $5 million or more in liquid investments. It can also include some investment real estate. So you have to be in the pretty rarefied air for this to work for you. But candidly, not only do we have a fair amount of people that are already in that bucket, we have a lot of people that will be on that path. Sure, they could be high income people. They could be two doctor families that are working and saving and doing really well. It could be business owners that will reach to that point.
We have several clients that retired very well and despite our best efforts, they’re not spending their money as much as we nudge them to do so. They live below their means and compounding works its wonders, so they can end up in that category too. So if you’re on a path to go ahead and get to this standpoint, this video is for you. Or if you’re there already for that matter, it can apply to you right away.
So what we’re talking about here is going into a specific sort of structure. The structure for this sort of TALS investment, it’s not a regular brokerage account that’s going to produce a 1099. It’s a limited partnership investment. Hedge fund is kind of a broader term for it as well that we can go into and we can invest in as long as we are SEC qualified purchasers. And in that investment structure, the structure matters. It’s taxed as something called a trader fund. Now, the trader fund status allows us many benefits. What I really want to focus on is that allows us to go ahead and have losses and it can flow through our tax return regardless of material participation.
So this is something that you may be familiar with if you own real estate. If you own real estate, it tends to be passive. So it creates passive gains or passive losses. It’s under the passive activity section of the internal revenue code. And most times, passive losses can only offset passive gains. There could be some exceptions to this. If you’re a real estate investor professional status, there’s different short-term rental loopholes that you can go ahead and legally pursue as well. However, there’s all our requirements to doing this. And candidly, most busy professionals can’t qualify for them. There’s risk in trying to do so.
TALS is different. In this structure, in this limited partnership investment, the material participation doesn’t matter. It’s at the trader fund status that basically negates having to go ahead and put in an hour requirement. So these losses can flow through to you. I know, you don’t want to lose money when you’re investing. Again, markets or volatile, may lose money is always kind of a disclaimer. You have to take risk to go ahead and pursue reward, but we’re not talking about intentionally losing money. We’re talking about using the tax assets we created in TALS to go ahead and couple with this LP strategy in the trader fund. Again, that’s how it’s going to be tax reported.
Within the hedge fund, they’re using certain investments that produce some interesting tax attributes. Here, really what they can do is bifurcate capital gain and business loss within the strategy because it is a trader fund and because of how the contracts, the swap contracts that they’re trading, are going to be taxed and reporting. It’s an important note that what we’re talking about here isn’t something that’s very risky from a tax perspective. Again, everybody has their own level of riskiness or not, but we’re talking about holding these investments through a platform like a Schwab and Fidelity. It’s passed their due diligence. They’re not recommending the investment, but they’re certainly not going to put something on their platform that they want to potentially get sued for. So it meets their criteria to be held on their platform, or at least reported through their platform, I should say.
Additionally, in terms of the K-1 that comes out from these limited partnership investments, it’s not some fly by night CPA firm. The one that we predominantly use for this investment is KPMG, one of the big four CPA firms that’s preparing the tax return and issuing the K-1. Again, do you think that they’re going to risk their reputation and business to do this if it was fraudulent? Of course not. So that’s an important side note.
But what happens on that K-1 is that you’ll have basically short-term capital gains and business losses that are reported. These swap contracts can be managed in a way where basically those two tax attributes can be bifurcated in a very sophisticated manner and flow through to you as the investor in the limited partnership, in the hedge fund, and receiving that K-1 with this interesting tax bifurcation.
So if we’ve created tax assets through a TALS brokerage account, these net capital losses, again, what I call tax assets, now we can use it in combination with this hedge fund strategy, the TALS LP is what we prefer to call it, to offset the capital gains that are being realized in the LP. So the capital gains to capital losses can be netted out. And now what we’re left with flowing through on our tax return are business losses.
What a game changer. Now, we don’t have to be a material participant, spend at least 500 hours or 100 hours materially participating in some of these strategies to go ahead and get not passive loss treatment, but allow those to flow through to us and take against our ordinary income. Here, those requirements don’t have to be met because of the trader fund status that is being reported. So those business losses can flow to us. If we have a business, if we have a positive K-1, that K-1 income can be offset. If you have a seven figure K-1 income here, we’re talking about incredibly significant tax avoidance done in a legal manner.
What if we don’t have a K-1 or what if you don’t have sufficient K-1 income to go ahead and offset and use all those losses? Well, here too, we can benefit. Subject to rules, they’re called the excess business loss rules. And here in 2025, it’s 626,000 that we could go ahead and deduct against our non-business ordinary income, things like wages, interest, bonuses. You can go ahead and have non-qualified dividends, royalty payments, for example. All of that is taxed at your highest rate, which is going to be higher than your capital gains rate. So when you have those losses flowing through, it can result in significant tax savings.
Now, we have a few things on our site that’ll help. And if you look in the description link below the video today, there’ll be a link to take you to our site. One is the tax-aware investing guide. That’ll go through this in some more detail. And when you go to that screen, if you look at the top right, you’ll be able to see a green button. If you want to go ahead and schedule a call and explore this and learn more, ask a financial question, click that button. If you want to get in more of the weeds, if you’re one of our beloved engineer type clients, if you’re sophisticated, if you want to run this by your CPA, go ahead. Candidly, I wrote a very technical article. Again, warning, technical article that’s on here. When you take a look at it’s called Tax-Aware, Long-Short Tax & Investment Strategies. Again, a mouthful. TALS for short, understanding business loss deductions.
Now, when you go and you check this out, what you’ll see there, there will be a case study. So let’s just highlight a few things here. You can read it for more details. But here we’re talking about this couple has W2 income of $300,000. They do have a business that they’re operating, which produces a $700,000 K-1 for them. Here, we’re also assuming that they’re going to do a $500,000 Roth conversion. They already have a million dollars of W2 and business income. Now we’re adding another $500,000 of income, ordinary income, converting that income into a Roth. $1.5 million total in ordinary income at this point. What we’re going to say here is like, let’s assume that we’ve been using TALS strategies for years building these tax assets and we have $2 million in net capital losses already accumulated. Now we’re going to go into the TALS LP, into the hedge fund. We go ahead and we do that. This hedge fund produces a $2 million ordinary loss, a business loss on the K-1. The ordinary loss is subject to these excess business loss rules.
So what does that mean? Well, we look and see what’s our business income? The 700,000. That is fully offset. Our wage income, again, not business income here, we’re talking about wage income. We have a $626,000 allowance in 2025 for married couple filing jointly. That $300,000 is fully offset. We have an additional $326,000 now that we can use. And here we see that could be used against a big portion of that $500,000 Roth conversion, making your net amount taxable only $174,000. So the net result for ’25 is $1174,000 taxable ordinary income. $674,000 is carried over now as a net operating loss. So this excess business loss converts into a net operating loss.
Are we getting in the weeds? Yes. Is it complex? Yes. Do you need to know how to do this from an investing and tax standpoint? Absolutely. This is not something that you’re going to DIY here and candidly, it’s something that most advisors aren’t aware of or cannot effectively implement at this standpoint. We’ve done many implementations over the last two years. We’re definitely more on the leading edge at this point in time as I sit here in October 2025, and we’re happy to be there and we’re happy to be adding these benefits for our clients.
Now, if we carry on down into year two, year two, let’s assume same income, but let’s just take TALS out of it for this year for simplicity and show what happens as that net operating loss is carried over. So they have $300,000 in W2 income. They have $700,000 in K-1 income, no Roth conversion income, no TALS income. Again, just keeping it simple and straightforward here. Now, if we go down to the table … So again, we have the business income, we have the W2 income. There’s a million dollars that’s there. $674,000 can be applied. Candidly, when we have the net operating loss, it does not matter the type of income when we’re applying the NOL. So here, again, the tax planning changes yet again, so we need to be mindful of this.
Now, $674,000 could be applied. It’s up to 80% test, meaning 80% of taxable income can be offset by an NOL. If the loss amounts were higher, say we have a million dollar loss, only $800,000 of that could offset the million dollars of income. So these all things come into play here. Again, it’s a multi-year approach, not only for your investments, but for your tax planning too. When you look at it overall, the federal tax savings, this is kind of a bit of a jaw-dropper. Year one without TALS losses, taxable income would’ve been $1.5 million, resulting in approximately $499,000 of federal taxable income. With TALS, $29,963. Is it zero? No. Could it be zero? Properly designed, it could be.
Now look, let you make your own judgment how much you want to pay in taxes, but certainly you can always donate money. You can charitably donate money. You can donate money on your tax return, probably one of the most unused lines on the tax form in history. But these are ways that you can go ahead and legally avoid taxes through both good sound investment planning done in a very sophisticated, tax smart manner.
When you get into year two, if you look at the combined savings, rather than paying $296,000 of tax in year two, that’s reduced down to $63,000 and change. $232,000 of tax savings. We’re talking about $700,000 plus of tax savings over two years for this situation. Now, these are high income numbers. I get it. Maybe this applies to you, maybe it doesn’t, but creating these tax assets makes sense for any taxable investor that is not going to spend down their taxable assets quite quickly. They’re going to be there and grow and compound.
If you’re a business owner, if you have high K-1 income, if you’re a surgeon, orthopedic, if you’re in radiation oncology and just crushing it, if you’re a high income professional, these strategies can work for you. Sure, ask your advisor if they can help you. I would be willing to bet that this is going to be new to them. And importantly, this is not just something that any CPA firm is going to be able to do from a tax filing standpoint. There’s a lot of complexity here. It needs to be thoughtfully implemented and coordinated. We’ve been doing it for more than two plus years at this standpoint, and if you’re interested in learning more, we’re happy to talk to you too.
Information provided is for informational purposes only and does not constitute investment, tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.