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Whitaker-Myers Wealth Managers is an SEC-registered investment adviser firm. The information presented is for educational purposes only and intended for a broad audience. The information does not intend to make an offer or solicitation to sell or purchase any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Whitaker-Myers Wealth Managers reasonably believes that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. Whitaker-Myers Wealth Managers has a reasonable belief that the content will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences. Please refer to the firm’s ADV Part 2A for material risks disclosures.

Past performance of specific investment advice should not be relied upon without knowledge of certain circumstances of market events, the nature and timing of the investments, and relevant constraints of the investment. Whitaker-Myers Wealth Managers has presented information in a fair and balanced manner.

Copyright (c) 2023 Clearnomics, Inc. and Whitaker-Myers Wealth Managers, LTD. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. All reports posted on or via www.clearnomics.com or any affiliated websites, applications, or services are issued without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally, but should not be construed as a recommendation to buy, sell, or hold the company's stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security--including mutual funds, futures contracts, and exchange traded funds, or any similar instruments. The text, images, and other materials contained or displayed in this report are proprietary to Clearnomics, Inc. and constitute valuable intellectual property. All unauthorized reproduction or other use of material from Clearnomics, Inc. shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Clearnomics, Inc. expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Clearnomics, Inc. reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.

  • Writer's pictureMatthew Harris

Should I pay attention to the Capital Gains Tax, and how will it affect me?

Taxes can be a frustrating and challenging topic to keep straight. Knowing what taxes come into play in various situations, with such a wide variety of taxes that most Americans encounter, can confuse investors. In this article, we will discuss Capital Gains.

 

So, let’s begin with what a Capital Gains tax is, which is simply paying a tax on the increase in value of an investment. Although this applies to any investment type, most people encounter this tax through investing in stocks and real estate. Most people will sell at least one home they own during their lifetime, so it may sound “unfair” to some to pay a hefty tax on a move from their home. However, some good news on this topic is that a single person can exclude $250,000 of capital gains and a married couple $500,000 of gains on the sale of their home. The only qualification on this exemption is that it must be your personal residence for at least 2 out of the last 5 years.

 

Does everyone pay the same rate on capital gains?

The answer is no, but it is less complicated than income taxes. Capital gains taxes have only three brackets versus 7 for income tax. Generally, most Americans will pay at a 15% rate, lower-income taxpayers may not pay any capital gains, and the top 3-4% of earners will pay 20%. The chart below lays out this year’s rate.

 



 

In addition, for any capital gains on investments paid at these rates, single filers making over $200,000 and joint filers making over $250,000 will pay an additional net investment income tax (NIIT) of 3.8%. The chart shows long-term capital gains, which are the most common with investment gains. In some instances, investors may be forced into selling in less than one year, or an unexpected huge jump in value almost forces investors to sell and pay short-term capital gains. So, any investment held for less than one year is paid at the taxpayer's income bracket.

 

Regardless of what income level you pay tax at, the long-term rate will always be lower than the short-term level, so if you are close to the 12-month period and don’t have to sell, waiting a month or so usually will make sense to pay less tax. A few examples where paying short-term rates is inevitable and may make sense is a day trader of stocks purposely looking for very short-term stock gains or a house flipper that wants to buy and sell within a few months.

 

Can I avoid paying any capital gains on my investment?

Yes, in some instances, of course. The IRS doesn’t want to make this too easy, but some smart ways exist to realize gains and avoid capital gains tax. In real estate, you can sell a house for a gain, and as long as you close on another form of real estate investment (they don’t have to be the same form of real estate) within 180 days, then all of your gains get rolled into the new property, and you owe no tax. This is called a 1031 exchange. A similar but much more accessible form of exchange is an annuity with an increased value you want to trade in for something better without triggering a tax, called a 1035 exchange. A hybrid approach between real estate and paper investments is to sell a physical property, do a 1031 into a Delaware Statutory Trust (DST), and pay no capital gains tax. Then, you would own a passive investment that pays you real income and not have to physically do any time-consuming and specialized work required to be a real estate owner.

 

One way to avoid paying capital gains is to do all your investment trading inside an IRA or a qualified account. This may seem obvious, but step back and look at properly structuring what you buy in what account. If you are going to do a lot of trading, then qualified accounts will make sense as you only pay income tax whenever you withdraw, or in the case of a Roth account, all of your gains are tax-free. Sometimes, size or access in various accounts may force someone to do stock trading in a brokerage or taxable account, so let’s explore making that the most tax-efficient.

 

Another way to avoid capital gains tax is to hang onto that investment property or huge stock gain until you die. The reason to never sell is that your heirs, usually your children, will receive a step up in basis, meaning that all the gains realized by the decedent are reset at the value as of the original owner’s death date. This can be a win/win for an owner and their beneficiaries and allow them to retain more of their wealth.

 

How can I be the most tax-efficient if I can’t entirely avoid capital gains?

Investors with brokerage accounts that make sense to trade investments in can use a few strategies that may dampen the capital gains hit. If the investor is going to hold primarily mutual funds and not individual stocks, then utilizing Exchange Traded Funds or ETFs makes more sense, as they are still diversified in holdings, sectors, and strategies, like mutual funds. Still, they trade like stocks, which do not trigger capital gains unless you sell. In most years, mutual funds will pass on capital gains tax, whether you sell any of your holdings or not, so you likely will end up paying more in gains over the fund's life. Regardless of what investment you hold, selling early in the year rather than at year-end, you can defer satisfying the tax for up to 16 months or more if you file an extension. Back to the short or long-term gain differences, especially if it is a mutual fund or an ETF, wait until you have passed the 12-month threshold before you sell to reduce your taxes. Again, for stocks that can be more volatile, you may be further ahead to lock in a high gain and pay the higher rate, but waiting a month or 2 in a diversified investment vehicle likely won’t dramatically affect your gain.

 

Tax Loss Harvesting Strategies

This falls under the idea of being more tax efficient, but more specifically, offsetting your gains with losses is a way to take a bite out of the tax bill you are dreading paying your winners. The IRS will only let you take a tax deduction of up to $3,000 in losses; however, if you have $20,000 of capital gains and $23,000 in losses, then you will not only not owe capital gains taxes but actually be able to receive a tax deduction for the additional $3,000 of losses that exceeded your gains. Using the same example, if your losses happened to be $27,500 in the same calendar year as the $20,000 gains, then you could only write off the maximum of $3,000 of losses this year but would have to wait to take the rest of your deductions over the next two calendar years. This strategy should be used to sell the stocks or ETFs/funds that make sense to get in and out of. So, selling a stock that is likely to keep running higher or one that you are down in but would seem likely to turn around, then missing the market gains, could be a more considerable detriment than getting to write-off losses or offset gains. On the other hand, being mindful of the tax loss harvesting strategy can motivate you to lock in strong gains and be willing to cut your losses before they fall further.

 

Let’s Summarize

Capital gains can be a love/hate topic because, if you are realizing them, it is because you have made a good investment that has increased in value. On the other hand, it can lessen the excitement of your “smart move” when you use already taxed money, then spend a fair amount of effort and take risks, and the IRS wants a cut. In most cases, investors still clear 85% of your gains (if in the 15% bracket). This makes the time and risk worth it in many cases, but much more of an increase will reduce total investments, as it may not be worth the risk for more investors. Also, remember the entire sale of stock, real estate, ETF, etc., is not taxed; only the gain is. If you are thoughtful and do your homework, you can reduce and sometimes eliminate capital gains tax.

 

If you have questions about capital gains taxes or anything related to saving for your future, contact one of the Financial Advisors at Whitaker-Myers Wealth Managers.

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Whitaker-Myers Wealth Managers is an SEC-registered investment adviser firm. The information presented is for educational purposes only and intended for a broad audience. The information does not intend to make an offer or solicitation to sell or purchase any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Whitaker-Myers Wealth Managers reasonably believes that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. Whitaker-Myers Wealth Managers has a reasonable belief that the content will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences. Please refer to the firm’s ADV Part 2A for material risks disclosures.

Past performance of specific investment advice should not be relied upon without knowledge of certain circumstances of market events, the nature and timing of the investments, and relevant constraints of the investment. Whitaker-Myers Wealth Managers has presented information in a fair and balanced manner.

Copyright (c) 2023 Clearnomics, Inc. and Whitaker-Myers Wealth Managers, LTD. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. All reports posted on or via www.clearnomics.com or any affiliated websites, applications, or services are issued without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally, but should not be construed as a recommendation to buy, sell, or hold the company's stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security--including mutual funds, futures contracts, and exchange traded funds, or any similar instruments. The text, images, and other materials contained or displayed in this report are proprietary to Clearnomics, Inc. and constitute valuable intellectual property. All unauthorized reproduction or other use of material from Clearnomics, Inc. shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Clearnomics, Inc. expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Clearnomics, Inc. reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.

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