Have you ever wondered the proper execution plan for exiting a non-retirement investment? The right execution plan must always account for the capital gains and tax associated. Whether you’re selling stocks, real estate, fine art, or precious metals, comprehending how capital gains taxes work can significantly influence your financial decisions and the tax burden you face annually.

What Are Capital Gains?

Capital gains occur when you sell a capital asset for more than the purchase price and realize the gain. Capital assets include stocks, bonds, ETF’s, real estate, collectibles, or even a business. To use an example, if you buy shares in XYZ company for $10,000 and sell them later for $100,000 you have realized a capital gain of $90,000. It’s important to remember that capital gains are only realized when the asset is sold. An increase in the paper value of your investment is considered an unrealized gain and isn’t subject to taxes. The asset must be sold to realize a capital gain.

How Are Capital Gains Taxes Calculated?

Capital gains taxes apply to the profit from selling an asset and depend on two major factors: the holding period of the asset and your overall income level.

Short-Term vs. Long-Term Capital Gains

• Short-term Capital Gains: Applies to assets held for one year or less and sold. These are taxed at your ordinary income tax rate. Depending on your taxable income, short-term capital gains land anywhere from 10% to 37%.
• Long-term Capital Gains: Applies to assets held for more than one year. These gains are taxed at either rates of 0%, 15%, or 20%, depending on your taxable income. This structure encourages long-term investments.

Factoring in Net Investment Income Tax

One consideration with capital gains is the net investment income tax. High-income earners might face an additional 3.8% net investment income tax on capital gains. For single filers earning more than $200,000, you will face a 3.8% net investment income tax. For married couples filing jointly and earning more than $250,000, they will face the 3.8% tax.

Exemptions and Special Cases with Capital Gains

While capital gains rules are straightforward, a couple special cases are worth noting:

• Primary Residence Exclusion: You can exclude up to $250,000 (for singles) or $500,000 (for married couples) from taxation if you sell your primary residence and meet the criteria of living there for 2 of the past 5 years.
• Capital Losses: Capital losses offset gains. The net sum between all losses and all gains determines the taxable impact. For instance, a $5,000 gain can be netted against a $2,000 loss, leaving a taxable gain of $3,000. A $10,000 loss netted against a $4,000 gain leaves a net $6,000 loss. If total losses exceed gains, up to $3,000 of losses can be deducted from income and carry forward any remaining losses over $3,000 to future years.

Managing Capital Gains to Reduce Tax Burden

When dealing with capital gains and tax liability, there’s important strategies to consider.

1. Timing of the Sale: Depending on your tax bracket, holding an asset for over a year could lead to significant tax savings through long-term capital gains rates.
2. Tax Loss Harvesting: Deliberately selling underperforming assets at a loss to offset other gains reduces the potential tax liability.
3. Gifting and Estate Planning: Donating appreciated assets or planning for heirs also confers tax benefits. Donating an appreciated asset with sizable unrealized gain to an eligible charity provides an immediate tax benefit. In this scenario, the gross value of the appreciated asset is eligible to be deducted, up to 30% of your adjusted gross income. Heirs often benefit from a step-up in basis to the date of death value, eliminating capital gains tax on any appreciation during the decedent’s lifetime.

Conclusion

Capital gains taxes play a vital role in financial planning. By understanding the nuances of capital gains taxation, you can effectively manage your tax burden without compromising your investment strategy. Seeking guidance from a certified financial planner and tax professional helps align your investment and tax strategy with broader financial goals.

Investments in real estate may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Other risks can include, but are not limited to, declines in the value of real estate, potential illiquidity, risks related to general and economic conditions, stage of development, and defaults by borrower.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Embark Financial Partners and LPL Financial do not provide specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.