Last week’s Retirement Watch Weekly covered ways to increase your after-tax investment returns. Let’s pick up where we left off.
When your investment strategy says it’s time to sell an investment, don’t hold it for months hoping it will mature to a long-term capital gain.
It might make sense to wait if it will mature into a long-term gain in only a few weeks but waiting longer might not be worth the tax break. When you do take short-term gains, look for losses you can take to offset them.
Know your tax bracket.
The tax on your gains can fluctuate with your tax bracket. If your income or deductions vary from year to year, you might factor that into your decision of when to sell.
Someone who normally has a very high income might avoid the 3.8% net investment income surtax by selling long-term capital gain assets in a year when other sources of income are lower.
Other people might find that lower income one year reduces their long- term capital gains rate below 20%, to 15% or even 0%.
In 2022, the long-term capital gains tax rate is 0% for single tax- payers with taxable income up to $41,675 and for married couples filing jointly with taxable income up to $83,350.
The 15% long-term gains rate applies to single taxpayers with taxable income up to $459,750 and married couples filing jointly with taxable incomes up to $517,200.
Only above those income levels will the 20% maximum rate begin.
The bottom line is that you might have an opportunity to take gains at a lower tax cost by selling in a year when you retire, lose a job, work fewer hours or business is down.
When large tax deductions one year reduce your taxable income, that also could be a good time to take some extra capital gains.
Also, consider other taxes in addition to the taxes on the gains when planning sales of profitable investments.
The gains will increase your adjusted gross income, and a higher adjusted gross income can trigger the Stealth Taxes, such as income taxes on Social Security benefits, the Medicare premium surtax, net investment income tax and more.
Many people take large gains in one year only to find that the higher gains triggered one or more of the stealth taxes, increasing their effective taxes on the sales.
It might be better to spread the sales over several years. Consider the potential for triggering or increasing the Stealth Taxes before deciding to sell profitable investments.
Make gifts of gains, but not losses.
You can give investment assets to family members and let them sell the assets. This could reduce the family’s taxes when the person receiving the gift, usually a child or grandchild, is in a lower tax bracket.
The tax rate on long-term capital gains might change from 20% to 15%, or even 0%. (The person receiving a gift has the same tax basis in the asset that you did, so he or she will have the same amount of capital gain as you would have.)
You want to be sure that the person receiving the gift isn’t subject to the Kiddie Tax, which would make the gain taxable at the parent’s top tax rate instead of the child’s rate. You don’t want to give an asset that has declined in value.
The recipient’s basis will be the lower of your cost and the current fair market value. That means no one would deduct the loss in value that occurred while you owned the asset.
It is better for you to sell the asset and deduct the loss on your return. Then, you can give the sale proceeds or something else.
Give appreciated assets to charity.
When your charitably inclined, consider donating an appreciated investment instead of cash. You’ll be able to deduct the fair market value of the asset on the date of the gift.
Plus, neither you nor the charity will owe any capital gains taxes on the appreciation that occurred while you owned the asset.
Giving an appreciated asset is likely to generate more benefits than writing a check to charity.
Hold investments for life.
When assets held in a taxable account are inherited, the heir increases the tax basis to the fair market value as of the date of the previous owner’s death.
No capital gains taxes are imposed on the appreciation that occurred during the previous owner’s lifetime.
Since the federal estate tax doesn’t apply to most estates, a good strategy when you own investments with substantial gains is to continue holding them so the next generation can inherit and sell them without incurring any taxes.
*For part 1 of this story – How To Increase Your After-Tax Investment Returns – follow this link.