7 Financial Strategies for Capital Gains Optimization
1) TAX LOSS HARVESTING
Although only $3,000 of net capital losses can be deducted in any one year against ordinary income on your tax return, the remaining balance can be carried over to future years indefinitely. When you follow this strategy, you want to be careful to avoid the rules about “wash sales” if you plan to repurchase the same stock within 31 days.
2) HOLD INVESTMENTS LONG ENOUGH TO AVOID SHORT TERM CAPITAL GAINS
It is rarely worth holding on to a stock you are ready to sell — with one exception. While gains recognized on stocks held for a year or less are taxed at ordinary income rates, gains recognized on stocks held longer than a year are taxed at the long-term capital gains rate — currently 15% for most investors and 20% for the highest earners. As a result, it may make sense to delay selling appreciated stocks until they qualify for long-term capital gains treatment.
3) IF YOU ARE IN A LOW TAX BRACKET
If you are early on in retirement, taking time off mid-career, a “FIRE (Financial Independence Retire Early) breather” and/or in the 10%-12% tax bracket, your capital gains tax will be zero. Under the Tax Cuts and Jobs Act of 2018, the income thresholds are $40,000 (single filers) and $80,000 (joint filers) for year 2020. Be careful that you don’t trip over the tax rules. As an example, the net gains from your stock sale count against the income limit.
4) LEVERAGE ‘STEP-UP BASIS’
This is for capital gains in your taxable account (not securities in a 401(k), IRA, or other tax-qualified retirement plan). Should you sell the stock during your lifetime, the net proceeds in this equation are your capital gains (or losses). Should you gift the stock, the cost basis carries over to the new owner.
However, when you die before selling or gifting, this cost basis in most situations is “stepped up” to the fair market value on the date of death. The stock escapes the capital gains tax on the price increase during your lifetime, regardless of the size of your estate.
5) DONATING APPRECIATED STOCK
Instead of selling the appreciated stock, paying the capital gains tax, and then donating the cash proceeds to charity, consider donating the stock directly. That avoids the capital gains tax. You could donate the shares to a Donor-Advised Fund (DAF) as it gives you time to evaluate the causes that you want to contribute to. Depending on your net worth and charitable contribution, also consider a charitable remainder trust or private foundation.
Read more about tax smart charitable giving in my blog: https://www.capitalvgroup.com/articles/2020/10/16/taxsmart-charitable-giving
6) ALTERNATIVE INVESTMENTS
These are complex investments and may have higher risks and lower liquidity which are not suited to all investors. Some examples include:
• Opportunity Zones
• Non-traded REITs
7) FINALLY, EDUCATE YOURSELF ON TAX SMART STRATEGIES ON YOUR TAXABLE INCOME
• Consider Municipal tax ladders if you are in a high tax bracket
• Contribute to your tax deferred accounts
• Utilize the ‘triple benefits’ of tax deferred HSA (Health Savings Account) plan.
Read more about HSA benefits in my blog: https://www.capitalvgroup.com/articles/2020/12/21/h-s-aplans-offer-triple-benefits
• Contribute to a ‘mega back door ROTH’ if your employer plan allows that
• And others..