10 Ways To Beat Capital Gains Tax
Last year's historically low capital gains tax rate of 15% is, well, history, but there are still ways around the new higher rates that went into effect Jan. 1. The 15% top capital gains tax rate went up to 20%. High income earners have to tack on another 3.8% (the net investment income surtax). Look at this before year-end if you want to avoid a surprise capital gains tax bill when you file your tax return next April.
"You start looking at these numbers, and it all adds up in a hurry," says R. Jeremy Wilson, a CPA and financial planner with Draffin & Tucker in Atlanta. One elderly client with $7 million of stock with $6 million of built-in gain is going to hold onto it until death rather than sell or give it to her adult children now. By running appreciated assets through your estate your heirs get your assets with a step-up in basis, and no capital gains tax is due. Call it the big deferral. Wouldn't you rather pay 0% than 23.8% capital gains tax?
Luckily, there are ways to exploit the 0% rate while you're alive. Those in an ordinary income tax bracket of 15% or below can sell stock at a 0% gains rate. For 2013 a couple can have up to $72,500 and a single up to $36,250 in taxable income and still be in the 15% ordinary income bracket. Add in the standard deduction and personal exemptions, and that translates into an adjusted gross income of up to 92,500 for a couple and $46,250 for a single filer. Take enough gains to fill up that 15% bracket.
If you're in a high bracket but your adult children or parents aren't, consider giving them appreciated stock. You can give $14,000 a year in cash or property each to as many individuals as you'd like without eating into your lifetime gift/estate tax exemption. The recipient of your stock gift takes on your basis—and later sells at the 0% rate.
Rethinking your retirement savings strategies can also help. A young doctor who's right on the cusp of getting hit with the 3.8% surtax (for singles earning more than $200,000/couples earning more than $250,000) was making his 401(k) contributions 50% pre-tax and 50% after-tax. He's shifted it to 75% pretax to keep him under the threshold for owing the 3.8% surtax, on the advice of his CPA, Stephen Bigge with Keebler & Associates in Green Bay, Wisc. "Don't be allured by the tax-free nature of the Roth," Bigge warns, adding that a 100% Roth 401(k) allocation makes sense for those who expect to be in the highest marginal tax bracket indefinitely, are in the lowest tax brackets, or are in lower tax brackets today but expect to be in higher brackets when they pull the money out.
Bigge is also helping clients ladder stock sales or exercise options over a period of time so as not to trip the top 20% rate and the surtax. Some clients are increasing their exposure to municipal bonds and making oil & gas investments so as to get the intangible drilling costs as a pre-AGI deduction to keep their income below the thresholds for the taxes kicking in.
If you don't want to change your investment mix, you can focus on basic strategies like harvesting losses to offset gains. Or take gains avoidance a step further. Philip Clinkscales, a financial planner with Sound River Advisors in Atlanta, sells out of mutual funds just before the fund manager declares capital gains payouts for the year, buys a similar exchange traded fund, and then buys back the actively managed fund.
Sometimes rebalancing just means paying gains tax, and shouldn't you be happy you have gains in the first place? Wilson advises a couple in their 30s, a lawyer and a corporate executive who earn $1 million and were rebalancing their portfolio and looking at more than $100,000 in gains. They were basically stuck with the 23.8% rate. "I told them, 'Let's just be thankful that in the current economy you both have that kind of income," he says. "I would always take paying the tax with a gain as opposed to offsetting my income with a loss."
Check out these strategies to bypass capital gains altogether or at least lessen the bite.
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