By Brian Bloxom, ChFEBCSM
Chuck Norris once said, “Between income taxes and employment taxes, capital gains taxes, estate taxes, corporate taxes, property taxes, Social Security taxes, we’re being taxed to death.” He has a point! Although generally we can’t avoid being taxed, there are some strategies to help us mitigate and manage our tax obligations. As markets fluctuate, not everyone thinks 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.
Take Advantage of 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 other methods, such as last-in, first-out (LIFO) and average cost. Be sure to consult your financial advisor before taking advantage of this option.
Keep an Eye on the Rules for 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?
You don’t have to be “taxed to death.” And you don’t have to make sense of this complicated topic on your own. We at Sentinel Wealth Partners are here to help you navigate all your options when it comes to mitigating capital gains taxes—taking into consideration your unique circumstances regarding your sales, cost basis, and length of time of ownership.
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 calling our office at 703-832-0164, sending an email to [email protected], or using our online calendar.
About Brian
Brian Bloxom is an Independent Financial Advisor, Chartered Federal Employee Benefits ConsultantSM (ChFEBCSM) and Chartered Retirement Planning Counselor℠, CRPC® professional with 25 years of experience in financial advising. He founded Sentinel Wealth Partners to serve retirees, individuals approaching retirement, and individuals managing complex retirement plans such as company plans or federal benefits plans. His expertise and dedication to helping his clients achieve their goals make him a trusted resource that will help you feel confident in your customized retirement plan. Brian’s mission is to be available to his clients—all the time. He’s here to solve your problems, relieve your anxiety, and give you optimism for retirement. Because ultimately, your retirement should be about well-deserved enjoyment, and not about stress or anxiety. When he’s not working, you can find Brian spending time with his wife, Jessica, and their two sons, Spencer and Preston. He enjoys coaching soccer, serving in his community, golfing, and relaxing at his vacation home at Lake Anna, VA. To learn more about Brian, connect with him on LinkedIn.
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(3) https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting
(4) https://www.nerdwallet.com/article/taxes/selling-home-capital-gains-tax