Capital Gains Tax Planning
Over the last 10 years, the average return on the stock market has been 12.58%, and the return for the last five years has averaged 13.71%. Housing prices have increased steadily for the past 11 years, with a significant spike following the pandemic. That means that savvy investors are currently facing a good problem—how to plan for and minimize capital gains taxes on highly appreciated investments.
Capital gains taxes are not the only thing to consider when looking to exit an asset, but they are certainly significant. Depending on your tax bracket and how long you’ve held the asset, capital gains taxes can take up to 37% of your profits. That’s why capital gains tax planning is crucial to your overall investment strategy.
What Are Capital Gains Taxes?
A capital gain is the profit you earn when you sell an asset. For example, if you bought stock in Tesla for $100,000 and then sold it for $1 million, your capital gain would be $900,000. Just like the Federal Government requires a portion of your income, it also expects a cut of your investment earnings.
Capital gains taxes apply to almost any investment you sell for a profit—stocks, bonds, cryptocurrency, primary homes, investment real estate, businesses, vehicles, gold and silver, and even collectibles such as art, stamp and coin collections, or jewelry.
Some tangible and intangible assets do not qualify for capital gains taxes. These include business inventory, accounts receivable, depreciable business property, copyrights, artistic compositions, and patents or inventions.
You can calculate your capital gain by finding the difference between the selling price and the price at which you bought the asset, which is called the cost basis. Even if your asset has appreciated, you do not owe taxes until you sell it. This is the difference between realized and unrealized gains.
For example, let’s say you bought $100,000 worth of Bitcoin (the cost basis), and it has since appreciated to $1.1 million. If it is still sitting in your wallet, you have an unrealized gain of $1 million and don’t owe any taxes. As soon as you sell the Bitcoin and receive the proceeds, you will realize a gain of $1 million and owe capital gain taxes on those proceeds.
The amount of taxes you owe varies depending on your income bracket, how long you’ve held the asset, and where you live. Some states levy an additional capital gains tax, with rates in California reaching as high as 13.3%. There are ways to legally minimize taxes, spread your tax burden out over time, or defer your taxes. Because capital gains taxes can potentially reduce the profits you receive by a third, a good capital gains tax planning strategy should be a key component of your financial planning.
Net Investment Income Tax
The Net Investment Income Tax (NIIT) is an additional tax that kicks in when you have income from investments and your overall income exceeds $200,000 for single filers or $250,000 for married couples filing jointly. The tax is an additional 3.8% on top of the rest of the capital gains taxes.
Short vs. Long-Term Capital Gains Taxes
Assets held for less than one year are considered short-term investments, and the IRS taxes them at the ordinary income tax rate. That means that the tax rate could be as high as 37%.
Assets held for over a year are considered long-term investments and are given preferential tax treatment. Long-term capital gain tax rates are 0%, 15%, or 20%, depending on your income. So, the simplest capital gain tax planning you can do is to plan to wait at least a year before selling your asset.
Timing
For many reasons, it might make sense to spread your tax burden out over time. If you realize a large capital gain in a single year, it can bump you up to a higher tax bracket and thus increase the taxes that you owe. When you are faced with paying $30,000 of taxes in one year (on a $1 million gain), it might put a strain on your flexible income and limit your investment options.
If you can spread that $30,000 tax burden out over two or more years, it can free up your cash flow and give you more investment options. There are capital gains tax planning strategies that give you the ability to spread out both your realized gains and your capital gain taxes over time, giving you increased financial freedom and control.
Capital Gains Tax Strategies for Minimizing Taxes
It is clear that planning ahead to legally minimize or defer your capital gain taxes is a smart move. So, what are some of the strategies you can incorporate into your capital gain tax planning?
Invest Long Term
Holding onto your assets for at least one year can potentially cut your tax liability in half. There are times when it might make financial sense to sell an asset quickly, but you should always consider the increased tax liability when doing so. Long-term assets are taxed significantly less than short-term assets.
Offset Gains with Losses
A capital gain is when you sell an asset for a profit. A capital loss is when you sell an asset for less than you purchased it. Not every investment in your portfolio is going to be a winner. You can sell your unrealized losses and use the capital losses to offset your capital gains. The IRS allows you to offset $3,000 of capital losses in a single year. You can roll the rest to the next year if you have more than $3,000 in realized losses.
It is important to note that capital losses are categorized into short-term and long-term losses in the same way that capital gains are. You can only use short-term losses to offset short-term gains; long-term losses can offset long-term gains.
Invest in a Tax-Deferred Retirement Plan
When you invest in a traditional retirement plan (401K, IRA), your pre-tax investment can grow without being immediately subject to taxes. You will have to pay ordinary income tax when you pull your money out after age 60, but at that point, you may be in a lower tax bracket and would owe fewer taxes.
If you invest your money in a Roth IRA, you must pay taxes before investing, but your earnings are not subject to taxes when you withdraw them.
Determine Your Cost Basis
Suppose you have invested in a company or a mutual fund, or you have purchased multiple cryptocurrency shares at different times and prices. In that case, you will need to determine your cost basis before calculating your capital gains. A professional tax consultant can help you minimize your overall tax liability by carefully choosing the cost basis for the investments you are selling. The first in, first out (FIFO) method is the most common. Still, you can also use the last in, first out (LIFO), dollar value LIFO, specific share identification, or average cost strategies.
Take Advantage of Optimal Timing
If you are nearing retirement, and retiring will put you in a lower income bracket, you might want to wait to sell until you can take advantage of a lower tax rate. On the other hand, if realizing a large capital gain will put you in a higher income bracket, you might want to consider spreading your gains over time, allowing you to continue paying a lower tax rate.
Defer Taxes with a Deferred Sales Trust
A Deferred Sales Trust is a form of installment sale that allows you to spread out your gains over time, thus spreading out or even keeping them in a 100% deferral state. This gives you flexibility, liquidity, and control.
How Does a Deferred Sales Trust Work?
With a Deferred Sales Trust, instead of selling your highly appreciated asset directly to a buyer, you sell to an independent, third-party trust that gives you a promissory note in exchange. The trust sells to the buyer and takes receipt of the proceeds. You don’t owe any capital gain taxes because you have not directly realized any gains.
The trust will pay you your proceeds in installments over time as laid out in the promissory note. Or, the trust can reinvest your pre-tax proceeds into other investments where they will continue to provide passive income. You only have to pay taxes on the interest received from the investments.
An Example
Let’s say that Mrs. Smith has been managing a rental property for 20 years, but she is tired of screening renters, fixing toilets, and answering late-night calls. She wants to retire and live off of a passive income stream. Because she has owned the property for so long, if she were to sell directly to a buyer today, she would make a $2 million profit. However, she lives in California and would owe 20% in federal capital gains taxes and 13.3% in state capital gains taxes, plus 3.8% of NIIT. That means she would owe $742,000 in taxes and only have $1.258 million left to invest.
However, if she uses a Deferred Sales Trust, she can reinvest $2 million before paying any taxes. Because she is retired, she sets up the trust to receive $150,000 a year to live off of. Because she is only receiving a portion of her gains, she does not owe NIIT taxes, and she is in a lower tax bracket and only has to pay 15% rather than 20% in federal capital gain taxes. She has the cash flow she needs, has lowered her tax liability, and was able to invest all $2 million of her proceeds, maximizing her returns.
Capital Gains Tax Planning for Maximizing Returns
With the help of a qualified tax advisor, you can make some long-term plans for your assets so that you can minimize your capital gains tax liability and maximize your returns. However, capital gains taxes can be complicated, and you will benefit from the knowledge and assistance of expert financial advisors. It is best to meet with a tax advisor well before you plan to sell your assets, as a successful strategy may involve long-term plans.
Capital Gains Tax Solutions
Our Capital Gains Tax Solutions team is uniquely qualified to help you with all your tax planning needs. We work with CPAs, tax attorneys, financial advisors, real estate professionals, and financial planners to help you reach your financial goals.
Experience
We have over 20 years of real estate and investment experience and 16+ years of experience in Deferred Sales Trusts. We have assisted clients with over $500 million in transactions using a variety of tax deferral and investment solutions, including 1031 exchange, Delaware Statutory Trusts, commercial real estate, multi-family, brokerage, and Deferred Sales Trusts. We have the skill set and the experience to help you craft a long-term strategy for managing and minimizing your capital gains tax liability.
Expertise
Our founder, Brett Swarts, is a well-known expert in Deferred Sales Trusts. He is an best selling author, podcast host, Deferred Sales Trust trustee, and founder of Capital Gains Tax Solutions. He hosts mastermind courses to help other financial professionals understand the power and versatility of the Deferred Sales Trust. Not only our clients but other professionals trust us to explain and clarify capital gains tax planning strategies.
Confidence
We stand behind our track record and our strategies. We are invested in using tested, legal, and reliable tax solutions. The Deferred Sales Trust tax strategy has withstood 14 IRS audits and eight state audits that all closed successfully with no changes and no findings. At Capital Gains Tax Solutions, we work with the create of the DST tax attorneys who provide lifetime audit defense, giving you peace of mind about your capital gains taxes and your standing with the IRS. We will assist you in connecting with our previous clients, who can answer your questions and share their experiences using the Deferred Sales Trust to meet their financial goals.
Start Planning Now
Whether you have investments in real estate, stocks, cryptocurrency, or a business, now is the time to meet with Capital Gains Tax Solutions to start your capital gains tax planning. Even if retirement is years away, or you aren’t ready to sell your asset now, we can help you build a financial strategy to meet your changing needs throughout your life.
We can set up a Deferred Sales Trust now to build it into your deal for whenever you are ready to sell. We will structure the trust to maximize your investments while also giving you the liquidity and flexibility you need for your unique stage of life–now or in the future.
We promise to give you a really good look at what we do and how we might be able to help you. If you like it and feel like it fits, then go ahead and make a decision and move forward, and let’s get started today. But we want to let you know that if you don’t like it, that’s completely okay too. We promise we won’t talk you into anything as our only goal is to help you figure out what is best for you. Our only request is that you just let us know clearly one way or the other.