Taxes on capital gains have been on the news and are the top topic for high wealth investors. For those earning more than $1 million in earnings, Tax increases proposed by the government could increase the tax rate on capital gains to finance initiatives that improve the U.S. economy.
Whether the tax hikes are pushed forward, or other changes occur later, being proactive in managing your investments can lower your capital gain tax bill and allow you to keep more of your funds to invest and expand.
Match asset location with the investment option
There are a variety of accounts for investment, many that are tax-advantaged. For instance, 401(k)s, IRAs, 529s, HSAs, and irrevocable trusts offer different tax advantages. Being mindful and deliberate about the accounts you put money into and the investments you choose to invest in the various types of accounts will help reduce the tax burden.
A good general rule is to use tax-advantaged accounts for traded positions more frequently or investment options that are tax-efficient and to put your buy-and-hold investment or other tax-efficient investments into brokerage accounts that are tax-deductible.
Have a long-term perspective
If you’re looking to liquidate your investments in your brokerage account with taxable status, look at the length of time you’ve kept each investment. If the asset you want to sell has experienced an increase, you’ll be taxed on capital gains. If possible, you should sell at least a year old investments to ensure that you pay the most favorable capital gains tax rates for the long term instead of the short-term capital gains tax rates.
Harvest tax losses
If you’ve made capital gains during the year, look over your tax-exempt account to determine the possibility that other investment options could result in capital losses. If so, recouping these losses, assuming that you’re willing to sell the investments, can aid in reducing capital gains that are not yet paid. Tax-loss harvesting permits investors to offset the equivalent of $3,000 in ordinary income per year. However, be wary of wash sales and cost basis calculations to remain within the guidelines.
After reversing losses in the current year, any additional capital losses may be carried forward to future years.
Most of the time, smart investors with the benefit of flexibility can anticipate an entire year filled with losses in the capital before reselling the investment portfolios with larger gain.
Harvest tax gains
In addition to capturing profits from capital loss, investment investors can also gain capital gains. This is because investors wait until years when their tax-deductible income is lower to gain capital gains from their investments.
There are many reasons that your tax-deductible income could change from one calendar year. Perhaps you’ve retired and are enjoying an income that is lower for a few years before the required minimum distributions start. Maybe you switched work or took a few days off and ended up falling in an income bracket that is lower than the norm.
Even if there are no changes to taxable income, again might be a good idea. Certain investors who wish to dispose of a winning stock might decide to unwind their stake over several years, spreading the tax implications. For instance, liquidating one-third of a holding at the close of 2020, one-third in 2021, and another third in 2022’s beginning could take just a little over an entire year; however, it would allow investors to split capital gains tax over the three years of taxation.
There are occasions when tax increases on capital gains could be in the near future. Selling your winning investment investments might be a good idea if you want to lower capital gains taxes that you could be liable for. Even if you purchase this same investment, setting the cost basis will help save you from paying more capital gains tax.
Like any tax strategy, take care in observing IRS rules. Wash sales must be conducted according to the rules, and selling assets can result in a different tax rate: the 3.8 percent tax on investment income net depending on your finances’ circumstances. It is important to talk with your tax professional before making any decision to ensure the plan will be beneficial to you.
Monitor mutual fund distributions
If you’re a fund-investor in a mutual fund, You could be in the tax bracket of capital gains at the end of every year. Mutual funds make income and capital gains throughout the year when they trade into and out of investment portfolios. In certain years, a fund could have enough losses to cover (or losses carried forward from previous years) to pay for gains realized. In other instances, capital gains have to be transferred to shareholders. This may be more prevalent if markets continuously reach new highs over an extended period.
At the close of this year, people may examine a mutual fund’s estimates of the distribution of capital gains. If the distributions are substantial for the fund you own, switch to a different fund to avoid the capital gains distribution.
Give away assets that are appreciated.
If you do not need to sell all your assets to pay for your daily expenses, donating the most appreciated securities to charities or your heirs may reduce the tax on capital gains.
You will avoid taxation on capital gain when you give appreciated security to charity directly instead of cash. This is an additional benefit over the tax deduction that comes with donations to charities.
If you give your appreciated security to heirs, they will be given an increase in cost basis following your death. This means that the value of the security on the day of your death will be the price basis to your successors.
Invest in distressed communities
In 2017, the 2017 Tax Cuts and Jobs Act provided a tax break that allows investors to delay and reduce capital gains tax by reinvesting capital gains in a Qualified Opportunity Fund. QOFs are a source of funding for communities in need across the U.S. This tax break is designed to create jobs and boost economic growth in these regions.
Some rules do apply. The taxpayer is required to return capital gains to a QOF within a period of 180 days. For the longer that the QOF investment is held, the greater tax benefits are available:
- The holding period of at least five consecutive years will exclude 10 percent of initial gains that are deferred.
- With a holding period of at least seven years, you will be able to exclude 15 percent of the initial gain deferred.
- The holding time of minimum 10 years will remove most, if certainly not all, of the gains deferred.
Consider securities-based lending
If you feel that the realization of gains on capital is expensive and you do not have the means to offset or decrease it substantially, a different option to consider is not claiming the gain at all.
Many brokerage firms permit clients with a tax-deductible brokerage account to utilize their securities as collateral for an unsecured line of credit. The benefit of having a credit line lets you have access to cash at any time. This is beneficial for investors who require money but prefer not to liquidate their investments or earn gains (or loss) at the wrong time.
However, if the investment’s value decreases, the brokerage firm will typically demand that the client pays for additional assets to refill the account. Additionally, securities-based lines of credit cannot be used to purchase other securities or repay loans for margins.
Find an advisor
Knowing the different ways to reduce capital gains tax could be beneficial for anyone, especially those in the higher brackets of taxation. A thorough understanding of the numerous aspects of these strategies will make sure that investors are following IRS guidelines. A seasoned financial advisor can assist you in navigating the waters of these strategies and, in particular, if they are in close contact with your tax professional to devise a successful tax reduction strategy that is appropriate to suit your needs.