Tips for Capital Gains Tax Planning

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

Capital gains – what better encapsulates our economic system than our ability to generate returns commensurate with our risk appetite? And with this risk comes preferential treatment in the form of lower capital gains tax rates. The logic is straightforward – recognizing the inherent risk of no guaranteed returns, the government offers incentives to invest and risk our savings. This, in turn, fuels greater investments, bolstering the economy for the collective benefit. In a world with high taxation and low incentives, there’s simply not enough of a reason to invest.

However, at the end of the day, Uncle Sam will still want his, and if you don’t have a careful tax plan in place, you’ll end up giving more than what is required.

In this article, we’re going to examine the ways you can improve the tax efficiency of your investments by simply operating within the investor-friendly framework the IRS provides us so you don’t end up giving away more than is necessary.

What Exactly Are Capital Gains?

To better understand how to manage the taxation of your investments, it’s important to know what capital gains actually are. When you turn a profit on an asset, such as a piece of property or a stock, you have earned capital gains. 

So, if you purchase a stock of Ford for $20, and sell it for $40, your capital gain is $20. However, that’s not the end of the story – in the U.S., there are actually two forms of capital gains – short and long-term, both with their own tax burdens.

Capital Gains Tax Rates

If you hold a stock for less than a year, you owe short-term capital gains, which are taxed the same way as regular income:

2024 Regular Income Tax Rates

2024 Income Tax Rates
If you hold that stock for more than a year and sell it, you owe long-term capital gains, which are much lower than regular income or short-term capital gains tax rates.

2024 Capital Gains Tax Rates

As you can see, those rates are much, much lower than traditional income rates.

Therefore, our first lesson is to try and hold assets for at least a year, if possible, to qualify for the long-term capital gains rate.

Asset Location

When it comes to retirement planning, we want to keep our taxable income as low as possible, both leading up to retirement and in retirement. The less we pay in taxes, the more money we have to stay invested, and the more momentum we will have for compound growth.

Not all investment accounts are created equal. Traditional retirement accounts such as the Traditional IRA and 401(K) may allow you to defer your income and the taxes on your earnings, but your withdrawals will be taxed at the higher regular income rate. 

Brokerage accounts allow for capital gains taxes, but don’t allow you to defer your tax burden to a later date.

That’s why we should consider the tax efficiency of both the account and the investments.

A stock held for 20 years in a traditional IRA will get the same high tax rate as regular income. However, keeping that same stock in a brokerage account will incur the lower capital-gains tax rate. Therefore, it may be optimal to keep stocks and other tax-efficient assets such as ETFs in a brokerage account. 

That leaves more room for less tax-efficient assets in our tax-advantaged accounts, such as bonds and mutual funds that could incur taxable gains each year in a traditional brokerage account.

Tax-Loss Harvesting

Sometimes, we need to liquidate our positions; perhaps we need cash, rebalance our portfolio, or simply are happy with the gains we’ve accumulated from stock and don’t want to risk losing what we’ve already made. When you sell that stock (hopefully, you’ve held it for at least a year), you’ll naturally owe tax. The tax bill could even be enough to negatively affect your tax bracket status.

To lessen the blow and potentially maintain a lower tax bracket, you can find a losing position in your portfolio that you’re willing to part with (if it makes sense to do so) and sell at a loss. You can then offset the profit you’ve made from the winning position with the loss of your losing position. 

IRS ‘wash-sale’ rules stipulate that you cannot repurchase assets used to offset taxes within 30 days; however, you can buy a similar stock or ETF to maintain your desired asset allocation. Just to be sure, though, it’s best to consult with a financial advisor to ensure you don’t accidentally violate wash-sale rules. 

Since investments within traditional and Roth retirement accounts like 401(K)s and IRAs grow tax-deferred or tax-free, and you do not realize capital gains or losses each year, tax-loss harvesting does not apply to these accounts.

Spread Out Capital Gains

You don’t have to sell an asset if you don’t want to, and if you’re in a higher tax bracket than normal, you can always wait to the next year to offload any positions. Alternatively, you can sell just enough of a desired stock to bring you to the edge of a tax bracket but not push you into it or unwind your position over a few years to avoid a large sell off that could incur a sizeable tax bill. 

Alternatively, if you foresee going up a tax bracket the following year (or if new tax laws will put you in a higher tax bracket), you may want to offload your positions early while in a lower tax bracket.  

This strategy does come with a fair amount of risk as there’s no guarantee that your asset’s value will remain the same. It very well may drop the following year to such an extent that you’ll have wished you had sold while you could. But that’s always the risk of investing; minus a crystal ball, we never know which way the winds will blow, or which direction a stock will take.

Keep an Eye on Mutual Fund Distributions

Mutual Funds pass their capital gains and dividends directly to shareholders, and unless you pay attention to when that will happen, you could have an unexpected capital gain or dividend income that can disrupt your tax plan. 

If you see a sizeable distribution coming that will negatively impact your tax strategy more than the benefit the distribution would bring, you have a few options: 

  • Sell the mutual fund and purchase another one that fits your needs to avoid the distribution.
  • Adjust other aspects of your investment plan, such as taking a smaller withdrawal from your taxable savings accounts.
  • Offset the capital gain portion of your distribution with a capital loss.

Avoiding a capital gain may seem counterintuitive – if we avoid them, we won’t develop compound gains, right? The point is simply to lessen the blow of the tax we incur so we have more overall funds to stay invested, and only in quite specific cases would we actually want to completely avoid a mutual fund distribution.

Give Away Your Appreciated Assets

If you’d like to wind down your estate in a tax-efficient way, it’s possible to do so via charitable donations and bequeathing securities to your heirs. 

Charitable Donations: Donating appreciated securities directly to a charity allows you to avoid paying capital gains tax on the appreciation. You may be able to claim a tax deduction for the full market value of the security. This can be more tax-efficient than selling the asset, paying capital gains tax, and then donating cash.

Estate Planning: Leaving appreciated assets to heirs can be beneficial due to the “step-up in basis” rule. The cost basis of an asset is it’s value at the time of purchase. The cost basis of securities is “stepped up” to their market value at the time of one’s death, allowing any heirs to sell their new assets with potentially little or no capital gains tax liability.

Putting It All Together

When it comes to retirement planning, keeping a close eye on taxable brokerage accounts and the impact of capital gains is vital for a tax-savvy retiremen and investment journey. These factors play a significant role not only in the growth of your investments but also influence other key areas such as Social Security benefits, Medicare premiums, and withdrawal strategies from tax-advantaged retirement accounts.

Also, each financial situation is unique, and other factors may also come into play, such as the asset protections afforded to retirement plans and liquidity needs.

Working with a financial advisor can be immensely beneficial in this context. A fiduciary advisor can guide you in strategizing the most effective order for withdrawals, capturing capital gains in a tax-efficient manner, and generally ensuring that your approach to handling taxable accounts aligns seamlessly with your broader financial objectives while always keeping your best interests at heart. If you’d like a consultation on how to improve your tax plan, we’d be happy to provide you one. All you need to do is click the button below and choose a day and time that’s convenient for you.

Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

Author

  • Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

    A Florida native, and full-time Sarasota resident, Ken founded WealthGen Advisors, LLC after spending more than fourteen years in the financial advisory industry. Ken holds multiple industry designations, as well as a master's degree in Financial Planning. Prior to founding WealthGen Advisors, Ken spent almost a decade in New York and then Texas as Vice President at The Capital Group, a $2T global investment manager serving institutional clients and pension funds.

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