In the NBC comedy series Parks and Recreation, parks department director (and staunch libertarian) Ron Swanson is asked to explain how government works to a young girl. Obviously, taxes were a hot-button issue. To provide an example of capital gains taxes, Ron grabs the sandwich the little girl is eating for lunch and takes a big bite. “Capital gains taxes,” he says as the poor girl looks on in shock.
Ron owned a lot of gold, so he had plenty of reason to hate capital gains taxes (more on that later). No one likes paying taxes, but capital gains taxes are especially unpopular amongst investors. Thankfully, there are plenty of legal ways to lower your capital gains tax burden or erase it altogether.
If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.
What are Capital Gains?
Capital gains taxes are fairly straightforward as defined by the IRS. If you sell a capital asset for a profit, you’ll incur a capital gains tax. A capital asset is any type of property or store of value, such as stocks, real estate, gold, jewelry, cryptocurrency, fine art, and yes, even your NBA TopShot moments. If you sell it for more than you bought it for, capital gains taxes will come into play.
Since capital assets are often bought with funds that have already been subject to taxation, the government gives a little bit of a break on capital appreciation. If you hold the capital asset long enough, you’ll pay a special rate of either 0%, 15%, or 20% on the realized gain. Only realized gains are subject to taxation. If you don’t sell the asset to realize the gain, you won’t be taxed.
Income brackets for long-term capital gains taxes are as follows:
- Under $40,001 ($80,001 married) – 0%
- Under $440,450 ($496,600 married) – 15%
- Over $440,450 ($496,600 married) – 20%
If you make $440,000 annually, your income tax rate is 35%, so a capital gains tax rate of 15% has a lot less sting behind it. Of course, these are the rates for long-term gains.
Short-term vs Long-term Capital Gains
The IRS makes a distinction between short-term and long-term capital gains which is crucial for profit and tax planning purposes. A short-term capital gain is defined as any profit from an asset held for less than one year. If you bought stock on January 1st and sold it on December 31st, your gain will be classified as short-term and it will be taxed at the same rate as your ordinary income, NOT the capital gains rate.
In order to reap the benefits of the long-term capital gains rate, you’ll need to hold the asset for longer than 365 days. If you buy a stock on January 1st, 2021, and sell it on January 1st, 2022, you’ll meet the requirements for a long-term capital gain. Yes, one day makes all the difference.
Considerations for Collectibles
The IRS doesn’t consider all assets to be equal. For most common capital assets like stocks and property, the 0-15-20 rate applies. But if you’re in the business of collectibles or precious metals, your capital gains rate will be a flat 28%, regardless of your income. If you own gold, art, stamps, or baseball cards, you’re getting hit with the 28% rate if you sell for a profit.
Tax Strategies for Minimizing Capital Gains
Capital gains taxes are reported to the IRS on Form 8949 or the Schedule D section of Form 1040. All capital gains must be reported, but there are a few techniques for getting your taxes waived or reduced. Here are a few cases:
- Primary Residence Exemption. If you sell a home for a profit, you’ll be subject to capital gains taxes. However, you can waive the first $250,000 of capital gains ($500,000 if married) if the home is your primary residence. You must own the home and reside it in for at least 24 months in a 5-year span. This exemption can also only be used once every 2 years.
- Capital Loss Carryovers. The IRS allows $3000 of capital losses to be written off each year, but excess amounts can be carried over into future years. If you have a $9000 capital loss in 2020, you can claim $3000 of capital losses on your taxes in 2021, 2022, and 2023. Just be aware of the wash-sale rules regarding capital losses, especially with equities.
- Roth IRA/401k. The Roth is a powerful tax-savings tool. Not only do Roth IRAs have looser restrictions on withdrawals, but the accounts are funded with after-tax dollars and investment grow tax-free. If you have investments in a Roth, those will grow completely free of taxation. Since distributions aren’t taxed, Roth IRAs and 401(k)s are great tools for balancing obligations to Uncle Sam in retirement.
Contact Good Life Financial Advisors of Mt. Pleasant
Understanding how capital gains tax works is important for investing. If you have any questions, reach out to a team member from Good Life Financial Advisors of Mount Pleasant for assistance.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earning from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.