By Bryan Trugman, CFPⓇ
Capital gains tax is a subject that comes up often when evaluating different financial assets. Capital gains can come into play with various types of investments, and there are often strategies that can help to alleviate the resulting tax burden. Part of our role is to help our clients understand the full implications regarding the decision to buy, hold, or sell an asset. Here are a few factors to consider.
We generally recommend that our clients hold onto their investments for at least a year in order to take advantage of long term capital gain tax rates, which are more favorable rates compared to short term capital gain tax rates. The question of when to sell often comes up when employers issue restricted stock units (RSUs) after shares vest. If you sell your shares within a year of when they vest, the sale of the shares could result in short-term capital gains, whereas if you hold the shares for longer than a year, any gains would be treated as long-term. Short-term capital gains are taxed as ordinary income based on your income bracket, whereas long-term capital gains for most types of assets are taxed federally at 0%, 15% or 20% (based on your income). (1)
Timing is also critical when it comes to the sale of real estate. If you sell your primary home, and you lived in the home for at least two years of the five-year period before the sale, the IRS allows you to exclude the first $250,000 of capital gains (or $500,000 for a married couple filing jointly). (2) While the capital gains exclusions do not apply to investment properties, you may be able to utilize like-kind exchanges to defer capital gains tax by reinvesting in other real estate.
Take Advantage Of Tax-Deferred Gains
Tax-deferred retirement accounts allow you to delay paying taxes on a portion of your earnings and any appreciation in value that would otherwise be subject to capital gains tax. 529 college savings plans, health savings accounts (HSAs), and flexible spending accounts (FSAs) offer the same advantage. If you are investing or paying for qualified expenses with after-tax dollars without utilizing these vehicles, you may be missing a significant tax savings opportunity.
Utilize Tax-Loss Harvesting (TLH)
It’s not what you earn that matters, but what you keep at the end of the day. Utilizing a tax loss harvesting strategy, you can claim capital losses to offset your capital gains. If you show a net capital loss, you can use the loss to reduce your ordinary income by up to $3,000 (or $1,500 if you are married and filing separately). Losses above the IRS limit can be carried over to future years. (3) Sometimes it is advantageous to sell depreciated assets for this reason. Most DIY investors don’t have tax management strategies when they invest. A TLH strategy can help minimize your tax liability and keep more money in your pocket. However, trying to reduce taxes shouldn’t come at the expense of maintaining a thoughtful asset allocation in your portfolio.
Choose Stock Lots For Best Tax Treatment
When you buy any amount of stock, the stock is assigned a lot number regardless of the number of shares. If you have made multiple purchases of the same stock, each purchase is assigned to a different lot number with a different cost basis (determined by the price at the time of each purchase). Consequently, each lot will have appreciated or depreciated in different amounts. Some brokerage accounts use first in, first out (FIFO) by default. If you utilize FIFO, your oldest lots will be sold first. Sometimes FIFO makes sense, but not always. Sometimes it is ideal to sell lots with the highest cost basis, which is commonly done as part of a TLH strategy.
Pass On Appreciated Assets By Inheritance
Assets passed on to the next generation at the time of death allow your heirs to pay tax only on capital gains that occur after they inherit your property, through a one-time “step up in basis.” (4) For example, when one spouse dies, assets passed on to the surviving spouse receive a step up in basis that eliminates the deceased spouse’s portion of capital gains.
We’re Here To Help
Capital gains tax is only one variable of many. It’s important to consider factors such as your long-term personal and professional goals, risk tolerance, and age. In the big picture, capital gains signify good news; your investments are doing well! Sometimes, it makes sense to pay capital gains tax and use the money to fund other investments or life goals. Other times, it makes sense to stay invested or find ways to defer capital gains. Many times, I recommend a combination of several strategies.
We enjoy helping our clients delegate the role of financial planning. If you would like to take a closer look at your plan to see which types of financial strategies best align with your goals, please feel free to reach out to me via email at email@example.com or give me a call at (516) 762-7603.
Bryan Trugman is managing partner, co-founder, and CERTIFIED FINANCIAL PLANNER™ (CFP®) practitioner at Attitude Financial Advisors. With more than 12 years of experience, Bryan specializes in addressing the financial needs of new parents as they seek to realign their finances, assisting divorced individuals as they navigate an unforeseen fork in the road, and strategizing with those seeking to accrue a dependable retirement nest egg. Bryan is known for being a good listener and building strong relationships with his clients so he can help them develop a customized financial plan based on what’s important to them. He is passionate about helping his clients experience financial confidence so they can worry less and play more. Bryan has a bachelor’s degree in industrial and systems engineering with a minor in mathematics from State University of New York at Binghamton. He has served on the board of the Financial Planning Association and continues to be actively involved in the national organization. He is also a member of the Plainview-Old Bethpage Chamber of Commerce, for which he has served as a vice president and board member. When he’s not working, you can find Bryan on the ballroom dance floor or engaged in a fast-paced game of doubles on the tennis court. To learn more about Bryan, connect with him on LinkedIn.