When an investment or asset is sold, such as stocks, bonds, or real estate, it may be subject to capital gains tax. The fact that you have a gain is something to celebrate, however, that gain will be taxed. But instead of dreading tax time and capital gains, there may be ways to minimize your capital gains tax. Let’s take a look at these 5 tips.
We generally recommend that our clients hold on to 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).
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). 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.
2. 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.
3. 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. 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.
4. 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.
5. Pass on Appreciated Assets by Inheritance
Sometimes you can give appreciated assets to charity or your children. 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.” 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.
I’m Here to Help
Capital gains tax is just 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.
I enjoy helping my clients find financial strategies that best align with their goals. To learn more, schedule a no-obligation introductory meeting by calling me at (619) 681-1911, emailing firstname.lastname@example.org, or scheduling a time online.
Paul Neves is president and wealth manager at FSI Wealth Management, a leading independent wealth management firm based in San Diego, California. Paul is a CERTIFIED FINANCIAL PLANNER™ professional and a Chartered Financial Consultant®. Working with clients in the financial industry since 1989, Paul has dedicated his life to seeing his clients and their families reach their goals and fulfill the financial plans they have created for their life. He believes that trust and respect are key to building strong, long-lasting relationships with his clients. Paul is known for helping families take the mystery out of preparing for today and tomorrow.
Paul graduated from San Diego State University in 1989 with a bachelor’s degree in business administration, concentrating in financial planning and services. He is currently a resident of Point Loma, California, where he spends his free time with his family and friends either boating, cooking, wine tasting, or traveling. To learn more about Paul, connect with him on LinkedIn.