Strategies to Avoid Looming Higher Capital Gains Taxes

Strategies to Avoid Looming Higher Capital Gains Taxes
Wooden blocks with the word Tax. Business and finance concept. Taxes and taxation. The tax burden

When looking at the various items under review in Washington, one, in particular, stands out. That’s imposing higher taxes on long-term capital gains. Rate proposals on investment gains is a top priority for the current administration. If passed, that could increase the current rate of 20 percent to a whopping 39.6 percent.

Keep in mind that taxpayers who pay taxes on net investment income already get taxed an additional 3.8 percent. Rather than go away, that would continue under the new proposal. Not that it’s any consolation, but President Biden’s increase on taxes focuses on individuals with an income of $1,000,000 or more.

If you fall in that category, there isn’t much you can do at the present since the tax hikes aren’t yet approved. Not only could the exact percentage change but also the income level. Even so, if you’re in a higher income bracket, you should prepare for whatever happens.

For instance, small business owners and real estate investors might consider selling property. Since that process takes time to complete, it’s better to make plans now rather than wait until Washington increases the tax rates.

Remember, the higher someone’s income, the greater the chance they’ll get hit with increased taxes after this year. So, now’s the time to look at options for handling highly appreciated assets held in taxable accounts.

The Right Way to Deal With Highly-appreciated Investments

One possibility that seems obvious is to sell highly-appreciated investments now. That way, you would only pay the maximum of 20 percent taxes. However, doing this could cause some serious issues.

  • Adds substantial capital gains to returns
  • Puts you in a higher income bracket
  • Includes Social Security benefits as part of gross income
  • Triggers the alternative minimum tax
  • Increases the surtax premium for Medicare
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So, to avoid the capital gains taxes expected to pass into law, you should hold onto your highly appreciated assets for as long as you live. After your death, you can include them in your estate for your beneficiaries. However, you have other options, as well.

When it comes to an inherited asset, beneficiaries increase their tax basis to fair market value. This occurs on the exact date of your passing. From there, your loved ones can sell the asset immediately to avoid paying taxes on the appreciation that accumulated during your lifetime.

Make Wise Investment Choices

One way to protect yourself from the looming capital gains tax increase is to invest even more wisely than you already do. For example, limit trading. All too often, investors buy and sell frequently, which is a mistake. Rather, you want to hold onto your investments for more than a year. As a result, the investment will qualify for the lower long-term tax rate on capital gains.

Another great piece of advice, don’t take too much capital gains within 12 months. If you do, you might find yourself in a higher tax bracket. Although you still want to use your investment expertise when making decisions, don’t overlook the possible implications of taxes.

Also, when you recognize capital gains, look in your portfolio for paper losses. If you have any, sell them. That will help offset a portion or all of the gains. A good rule of thumb is to take paper losses whenever you don’t expect to have long-term capital gains within any given year.

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You can deduct as much as $3,000 of capital losses that go beyond capital gains against other income types. Also, you can carry any losses forward that aren’t used within the current year.

Smart Estate Planning

Another strategy worth considering is to include appreciated investments in your estate. Then you can pass the assets down to loved ones in lower tax brackets. Not only can they sell the assets without incurring high capital gains taxes, but this would also boost the after-tax wealth of the beneficiaries. Inheritance planning is the best way through which you can secure the future of your family. By paying taxes well in time, you can save your family from facing difficulties in attaining assets upon your death.

Financial Planning

Run tax planning scenarios using financial software that allows you to see the impact of having more capital gains. WealthTrace is a very good financial planning application for consumers that allows individuals to run tax planning scenarios including higher tax brackets, more capital gains, and higher inflation that might impact taxes.

Donating to a Charity

If you don’t have family or prefer to leave your estate to a charitable organization, you have some options that will limit or eliminate capital gains taxes. Since charities have non-exempt tax status, they don’t pay taxes. However, you’ll get a deduction that’s the same value of the investment on the date you make the contribution. If the charity wants to sell the asset, it can, and again, without paying taxes.

You might also think about donating your appreciated assets to a charitable gift annuity. In this case, you’ll get a portion of the property’s value in the year you make the contribution. As far as the actual donation amount, that depends on things like the current interest rate and your age.

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You have the option to donate your appreciated assets to a charitable remainder trust too. As with several other charitable strategies, you’ll get a deduction for a portion of the investment’s value. Even better, you won’t need to pay capital gains. With this, the remainder trust pays you income for as long as you live. After death, whatever’s left in the trust goes to the charity.

Utilize the Services of a Reputable Financial Advisor

As you can see, there are many ways to avoid paying the looming higher capital gains taxes. To determine which strategy is best for your specific situation, spend time with a trusted financial advisor. This expert will answer your questions and help you make well-informed decisions.

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