Making Cents: Keeping Capital Gain Taxes In Check

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By: John Napolitano  CFP®, CPA, PFS, MST

Since the top capital gains tax rate has risen to 20%, the thought of selling a winning investment may now be clouded with fears of getting clobbered with capital gains taxes. In addition to the new 20% rate, high bracket taxpayers may also get stung with the additional 3.8% surtax on investment income which included capital gains.

One of the methods of minimizing the tax bite from winning investments is to sell some losers. It is only your net capital gains that get taxed, and you may offset gains from the sale of winners with the losses from the sale of losing positions. For some this may be hard to do. 

You can sell a loser and then buy it back 31 days after the sale.  If you buy the same investment back within 30 days of the sale however, the loss will be disallowed under the IRS’s wash sale rules. If you are impatient, you can buy a similar investment within the 30 day period, but not the same or “substantially identical” holding.

Another tactic seems counter intuitive, but it actually involves accelerating capital gains or other income in years where your income is very low.  If you are in the 10 or 15% income tax bracket, for example, your capital gains tax rate will be 0. The 20% rate kicks in when a taxpayer reaches the threshold of hitting the 39% rate on ordinary income.  Everyone in between the top bracket and the two lowest brackets will pay a 15% federal capital gains rate.

A taxpayer who finds themselves in one of the two lowest tax brackets may consider selling their winners now and repurchasing them tomorrow simply to re-set their basis. Wash sale rules only apply to losing sales, so selling a winner at a 0 capital gains rate and then re-buying that same exact investment the next day gives you a new tax cost or basis, which may save capital gains taxes later when you sell that holding again. A taxpayer may also consider “using up” their low tax bracket by taking retirement distributions or doing a partial Roth conversion. Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

Two final notes.  Don’t forget your state.  Even many states with no income taxes still levy some sort of tax on investments or capital gains.  And the second rule is not to let the tax tail wag the dog.  When it is time to part with a winner or simply re-balance your portfolio, allowing taxation to drive that decision may not be in your best long term interests.

 

 

John P. Napolitano CFP®, CPA is CEO of U. S. Wealth Management in Braintree, MA.  Visit JohnPNapolitano on Facebook or uswealthnapolitano.com.  John can be reached at 781-884-2390.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. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk, including the loss of principal.  John Napolitano is a registered principal with and securities offered through LPL Financial. Member FINRA/SIPC.  Investment advice offered through US Financial Advisors, a registered investment advisor. US Financial Advisors and U.S. Wealth Management are separate entities from LPL Financial.