Strategies to Avoid Capital Gains Taxes on Investments
When deciding to sell out of an investment in a taxable investment account it is important to consider the potential tax ramifications of any decision you make. Generally, any investment held for less than a year will be subject to regular income tax rates upon sale while any investments held for over one year will be subject to more favorable long term capital gains tax rates. With some thoughtful planning, there can be opportunities to avoid capital gains taxes on investments altogether.
0% Long-Term Capital Gains Rate
Those with an Adjusted Gross Income (AGI) below a certain limit can find themselves in the 0% long term capital gain bracket where there is no tax impact for realizing a gain. We most commonly encounter this planning opportunity during the retirement tax planning window where someone has stopped working and their taxable income drops before social security, pensions, and required minimum distributions start to kick-in.
In 2023, the 0% long-term capital gains rate is applicable to those with an AGI below:
Married filing Jointly
Head of Household
Married filing Separately
Tax Loss Harvest to Offset Gains
If you have taxable investments that have gone down from their original purchase price, they can be used to offset the gains to potentially net the tax impact to $0. It is important to pay attention to the holding period of the investment you are tax loss selling as long-term losses will first be used to offset long term gains while short term losses will first be used to offset short term gains. Once you have netted the long-term and the short-term they will then net against each other.
Example: Dave has the following realized gains and losses: $10,000 short term gain, $4,000 short term loss, $15,000 long term gain, $20,000 long term loss. He will first net the short term against each other ($10,000-$4,000) for a net short-term gain of $6,000 and the long term against each other ($15,000-$20,000) for a net long-term loss of $5,000. He will then net the short-term gain against the long-term loss for a total net short term gain of $1,000.
When realizing a loss it is important to be aware of the IRS Wash Sale rule when reinvesting the proceeds of the sale. If you repurchase the security in the 30 days prior to the realized loss or 30 days after, the loss will be disallowed and the amount of the loss will be applied to the cost basis of the new security. Additionally, the rule prohibits you from purchasing a substantially identical investment in that timeframe as well.
Never Sell and Get a Step-Up at Death
For investments that are considered part of your estate, holding until death means potentially never having to pay taxes on the growth of your investment. Upon death, the assets receive a step up in basis and your heirs can then sell out of the security without having to pay taxes on the growth that occurred during your lifetime.
For married individuals, it is important to be aware of how step up works in jointly held accounts. This is largely determined by whether the state that you live in is a community property state.
Community Property States
In community property states, like Texas and California, when the first spouse dies the jointly held assets receive a full 100% step up in basis. This allows the surviving spouse to sell any investments they would like without paying taxes on gains that occurred prior to the first spouse’s death.
Non-Community Property States
In states that are not community property states, jointly held assets are considered joint tenants with rights of survivorship (JTWROS) and receive a 50% step up in basis upon the death of the first spouse. This lessens but does not eliminate the tax impact if the surviving spouse chose to sell investments after the death of the first spouse. Assuming the account remained owned solely by the surviving spouse for the remainder of their lifetime, the assets would then receive a 100% step up at the second spouse’s death.
Gift Appreciated Stock
When you gift appreciated stock instead of cash you not only receive the tax benefits of gifting but you also never have to pay capital gains taxes on the growth of the investments. Additionally, the charity that receives the gift is able to sell the appreciated stock with no tax liability as a charitable organization.
Depending on the charitable intent of the donor, this strategy can be paired with the establishment of a donor advised fund to maximize tax benefits or to diversify out of an investment with gains that are larger than the current planned giving of the owner.
Gift Gains to Those in Lower Brackets
If gifting assets out of your estate is currently part of your estate planning strategy, gifting appreciated stock instead of cash can potentially be a way to reduce or even eliminate the tax liability of realizing a gain.
When you gift an investment, the gain is not eliminated but the recipient now bears the burden of paying the tax when they ultimately sell the investment. If you are in a high tax rate, it can potentially lower the tax impact of selling by gifting the appreciated stock to someone in a lower tax rate. If that person is below the AGI limitations for the 0% capital gains rate that impact could potentially be eliminated altogether but you will want to be aware of “kiddie tax’ rules.
Additionally, you will want to consider the benefits of gifting the stock against holding until death and receiving a full step up in basis at that time as it may be more beneficial from a tax standpoint but would require you to hold the investment for the remainder of your life.
Each of these strategies may have considerations based on your specific situation and it is always important to discuss them with your CPA or a financial professional. If you’d like to have an introductory call to discuss your situation with our team click here to schedule a call.
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Disclosure: Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss.
Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we do not provide advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.