By Trent Derrick, CMT®
It was Benjamin Franklin who said that nothing is certain except death and taxes. Although generally we can’t avoid being taxed, there are some strategies to help us mitigate and manage our tax obligations. As we watch the market go up and down (and then up again), we rarely think about the taxes we might pay with the rise of our portfolio or home value—but we should.
The amount of capital gains taxes you pay is dependent on the amount of time you hold your assets. Having an investment for a year or less will trigger short-term capital gains taxes, which are taxed as ordinary income as high as 37%, in some cases. (1) Long-term capital gains taxes are based on your income and are taxed at 0%, 15%, and 20%. (2) While the simplest way to pay lower capital gains taxes is to hold your assets for more than a year, there are other strategies to prevent taxes from eating away at your wealth.
Use Tax-Advantaged Accounts
Saving for retirement is one way to avoid taxes on capital gains. With tax-deferred accounts (think IRAs and 401(k)s), you’ll only pay ordinary income tax when you withdraw the money, and you won’t face capital gains taxes on the growth. The same goes for Roth IRAs. Not only will you benefit from avoiding income taxes on the withdrawal if you are 59½ and have held the Roth for more than five years, but you’ll also avoid capital gains taxes.
Strategize Your Gains & Losses
Not all your stock picks are going to provide growth, and there may be times when you have to make some tough decisions about your portfolio. Tax-loss harvesting is a strategy that allows you to offset your capital gains by capital losses. If you own a losing bond, mutual fund, or stock in accounts other than your 401(k) or IRA, review your realized and unrealized gains and losses. You might be able to offset some of your gains by selling some losses, thus lowering your taxable income. And if you live in a high-tax state, you may want to defer tax by deducting up to $3,000 of capital losses in excess of capital gains and carrying any leftover capital losses forward into future years. (3)
Cost basis is another piece of the capital gains tax puzzle to keep in mind. Cost basis is the amount you paid for your asset. There are many ways to decide what cost basis to use if you have multiple asset purchases in different periods. Most investors use the first-in, first-out method (FIFO), but there are methods, such as last-in, first-out (LIFO) and average cost. Be sure to consult your financial advisor before taking advantage of this option.
Check the Rules on Your Other Assets
If the asset in question is real estate, you may be in luck. Currently, homeowners can sell and exclude up to $250,000 (for single tax filers) or $500,000 (for those who are married filing jointly) of the gains if you owned the property and lived in the house for at least two of the five years prior to selling it. (4) Even better, you can claim this exclusion on another property in the future as long as it’s been more than two years since you previously claimed it.
Business profits are also excluded from capital gains tax and instead are subject to business tax rates. In general, capital gains taxes apply to the sale of personal assets. Your business income is reported differently on your tax return and won’t face capital gains taxes.
Do You Have More Capital Gains Questions?
Capital gains taxes can get complicated quickly. There are many alternative strategies for those who want to offset or defer capital gains taxes or need to structure their income in a way that minimizes taxes. Luckily, you don’t have to figure it out alone.
If you want to examine your options and work to set up your investments to operate at their full potential so you won’t face unnecessary tax penalties down the road, schedule your complimentary introductory meeting by scheduling online or emailing me at firstname.lastname@example.org.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Trent Derrick is a financial advisor and Chief Market Technician at Legacy Wealth Management. Trent is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning, cash flow management, retirement planning, and bookkeeping. Trent has a bachelor’s degree from the College of Charleston and studied economics at the University of South Carolina, Columbia. He is a Chartered Market Technician® (CMT®) professional. Trent serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. When he’s not working, Trent, a proud Eagle Scout, enjoys volunteering with the Charleston Animal Shelter’s outreach program. Trent and his wife love to cook international cuisines and host dinner parties with their friends. To learn more about Trent, connect with him on LinkedIn._____________