By the Wealth Management Resources Team
It’s common to forget about capital gains when our investments are doing well. But when we sell an asset or investment for a profit, that profit is subject to capital gains tax. While there are many variables on how much your capital gains tax rate could be, there are some basic strategies you can explore to help minimize the amount of capital gains you ultimately pay. Let’s dive in.
1. Timing
In taxable accounts we generally recommend that our clients hold onto their investments for at least a year in order to take advantage of long-term capital gain tax rates, which are more favorable rates compared to short term capital gain tax rates. The question of when to sell often comes up when employers issue restricted stock units (RSUs) after shares vest. If you sell your shares within a year of when they vest, the sale of the shares could result in short-term capital gains, whereas if you hold the shares for longer than a year, any gains would be treated as long-term. Short-term capital gains are taxed as ordinary income based on your income bracket, whereas long-term capital gains for most types of assets are taxed federally at 0%, 15% or 20% (based on your income).
Timing is also critical when it comes to the sale of real estate. If you sell your primary home, and you lived in the home for at least two years of the five-year period before the sale, the IRS allows you to exclude the first $250,000 of capital gains (or $500,000 for a married couple filing jointly). While the capital gains exclusions do not apply to investment properties, you may be able to utilize like-kind exchanges to defer capital gains tax by reinvesting in other real estate.
2. Take Advantage of Tax-Deferred Gains
Tax-deferred retirement accounts allow you to delay paying taxes on a portion of your earnings and any appreciation in value that would otherwise be subject to capital gains tax. 529 college savings plans, health savings accounts (HSAs), and flexible spending accounts (FSAs) offer the same advantage. If you are investing or paying for qualified expenses with after-tax dollars without utilizing these vehicles, you may be missing a significant tax savings opportunity.
3. Choose Stock Lots for Best Tax Treatment
When you buy any amount of stock, the stock is assigned a lot number regardless of the number of shares. If you have made multiple purchases of the same stock, each purchase is assigned to a different lot number with a different cost basis (determined by the price at the time of each purchase). Consequently, each lot will have appreciated or depreciated in different amounts. Some brokerage accounts use first in, first out (FIFO) by default. If you utilize FIFO, your oldest lots will be sold first. Sometimes FIFO makes sense, but not always. Sometimes it is ideal to sell lots with the highest cost basis, which is commonly done as part of a tax-loss harvesting (TLH) strategy.
4. Pass On Appreciated Assets by Inheritance
Assets passed on to the next generation at the time of death allow your heirs to pay tax only on capital gains that occur after they inherit your property, through a one-time “step up in basis.” For example, when one spouse dies, assets passed on to the surviving spouse receive a step up in cost basis that eliminates the deceased spouse’s portion of capital gains.
Capital Gains Tax in 2022
Capital gains tax rates are the same in 2022 as they were in 2021; however, the income required to qualify for each bracket goes up to adjust for inflation. The maximum zero-rate taxable income amount is $83,350 for married filing jointly and surviving spouses, $55,800 for heads of household, and $41,675 for taxpayers that are married filing separately.
We’re Here to Help
Capital gains tax is only one variable of many. It’s important to consider factors such as your long-term personal and professional goals, risk tolerance, and age. In the big picture, capital gains signify good news; your investments are doing well! Sometimes it makes sense to pay capital gains tax and use the money to fund other investments or life goals. Other times, it makes sense to stay invested or find ways to defer capital gains. I usually recommend a combination of several strategies depending upon each client’s needs. You should always consult with a qualified tax advisor on how any recommendation or suggestion we provide applies to your own tax situation.
At Wealth Management Resources, our experienced financial advisors can help you manage your finances, develop a strategy for meeting your goals, and guide you through the personal financial planning process. To schedule an introductory appointment with me, call (401) 356-1400 ext. 112 or email amedici@wealthmanagers.com.
About Alex
Alexander Medici is vice president and investment analyst at Wealth Management Resources, Inc., an independent, fiduciary financial planning and investment management firm providing simple-to-understand guidance and solutions that help their clients pursue their goals. Alex has more than 15 years of experience and currently holds his FINRA Series 7, Series 63, and Series 66 licenses. He earned his bachelor’s degree in finance from the University of Rhode Island, as well as his Master of Business Administration in Finance from Suffolk University. In addition, he has earned the Certified Investment Management Analyst (CIMA®) designation from the Investment Management Consultant’s Association (IMCA) at the Wharton School of the University of Pennsylvania. Alex serves our broker-dealer customers as a Registered Representative and our investment advisory customers as an Investment Advisor Representative. To learn more about Alex, connect with him on LinkedIn.
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The information provided is for educational purposes only and is not intended to provide any investment, tax, or legal advice. The information provided in this article has been compiled from sources we believe to be reliable, but cannot be guaranteed to be so.