Investment securities, real estate, or investment properties are a few assets that qualify for capital gains tax treatment. Unlike income or sales tax, capital gains taxes are owed when a capital asset is sold at a profit. Depending on the value when the item was purchased and the value when it was sold, capital gains taxes can be significant.
The gain on assets held for less than one year before sale will be taxed at the seller’s ordinary income tax rate, while the gain on assets held for more than one year will be subject to the long-term capital gains tax rate.
Proper planning is crucial to minimize or avoid capital gains taxes.
What are the capital gains rates?
Depending on taxable income, basic long-term capital gains rates for individuals are 0%, 15%, or 20%. Income thresholds are adjusted for inflation.
These are the basic capital gains rates for 2022:
0% for taxable income up to $41,765 for single or married taxpayers filing separately, up to $55,800 for head of household, and up to $83,350 for married filing jointly.
15% for taxable income from $41,676 to $495,750 for single taxpayers, $41,676 to $258,600 for married filing separately, $55,801 to $488,500 for head of household, and $83,351 to $517,200 for married filing jointly.
20% for taxable income over $459,750 for single taxpayers, over $258,600 for married filing separately, over $488,500 for head of household, and over $517,200 for married filing jointly.
Note: There is a capital gains exception for primary residences, unlike other real estate. The first $250,000 (or $500,00 for married couples filing jointly) of a primary dwelling is excluded from income if the seller owned and used the property as their main home for at least two of the last five years.
These planning strategies can help you minimize or avoid capital gains taxes and increase the amount of money you keep.
1. Hold taxable assets longer.
When deciding the right time to sell an asset, consider how long you have held it and whether there would be a significant difference in taxes based on short-term or long-term capital gains treatment. Holding on to an asset for at least one year will allow you to benefit from long-term capital gains rates. Short-term profits are taxed at the same rate as ordinary income, which can be much higher than the rate for capital gains, especially for higher income earners.
2. Invest in tax-deferred retirement plans.
Tax deferred retirement plans are a key component for saving while minimizing tax liabilities. Certain retirement account funds grow on a tax-deferred basis and gains are not taxed when earned in retirement plans. Many taxpayers are in a lower tax bracket at retirement, so when disbursements are taken the taxes paid can be far less than they would have been during working years. Contributions to a 401(k) or traditional IRA not only minimize future capital gains but also lower taxable income, making these accounts a crucial part of a smart financial plan.
3. Balance good and bad investments.
Some investments perform better than others. While no one wants to take an unnecessary loss, you can take advantage of underperforming investments to offset other capital gains. Selling at a loss can minimize the tax liability from other gains and up to $3,000 of ordinary income per year. Unused losses can also be carried forward to minimize future gains. Taxpayers who use this strategy should be aware of the 30-day “wash sale rule” when selling stocks.
4. Donate assets to charity.
Appreciated investments that are donated to charity are generally not subject to any capital gains taxes. They are also eligible for a charitable donation tax deduction for the fair market value on the date of donation. This is a good option to avoid capital gains taxes and decrease tax liability.
Proper planning is essential to minimize capital gains taxes. These strategies can help you make the most of your unique situation. If you have questions, contact HFM today.