Our Tax Apprentice, Tommy McGrath, explains proposed changes to the Capital Gains tax:
Tax laws and regulations are constantly changing each year. With a new administration sworn in on January 20th, this year is no different. Capital gains tax rates have been a controversial topic within the past few months. Capital gains are the profit derived from the sale of certain assets. These assets include stocks, bonds, homes, cars, land, etc. The gains from a sale are subject to taxation. Short-term capital gains are the profits derived from the sale of an asset that has been held for less than one year, while long-term capital gains are the profits from selling an asset that has been held for more than one year.
Current Long-term capital gains tax rates are 20% for single filers making more than $441,451 per year and the same for married filing-jointly filers making more than $496,601 per year. The new administration is proposing drastic increases to long-term capital gains tax rates for top earners. They propose to increase the current rate of 20% to 39.6% for households making more than $1 million per year. By almost doubling the rate for certain filers, taxpayers within this threshold that have long-term assets will have to start thinking about what they are going to do with these assets. On top of the rate increase, the new administration is proposing making the increase retroactive. This would mean that any long-term capital gains that were already sold but within the retroactive timeframe would be subject to the higher rate.
To avoid these higher long-term capital gains tax rates, filers have a few options. The first and most obvious solution is to hold on to the asset if possible. In terms of stocks, filers can reinvest dividends rather than selling strong investments, which would then be subject to either short-term or long-term capital gains tax rates. Short-term capital gains tax rates are typically much higher than long-term rates for filers in the lower thresholds. Therefore, holding on to the asset for more than one year to get those lower long-term rates is more beneficial. Another strategy to reduce taxes is to use tax-advantaged accounts such as 401(k) plans and 529 college savings accounts which can grow tax-free or tax-deferred. This means that capital gains tax rates will not apply to investments that are sold within these accounts.
A strategy to help minimize taxable gains on the sale of a home can be utilized thanks to the IRS. The IRS allows single filers to exclude up to $250,000 and married filing-jointly filers to exclude up to $500,000 of capital gains on real estate. The only requirements are that the filer must own the home as his/her primary residence for at least two years. Also, the filer(s) must not have excluded capital gains on another sale within those two years of owning the primary residence. Some filers can also qualify for an additional exemption from the IRS if the sale of their home has a taxable gain, and they are selling it due to work, health, or an otherwise unforeseeable event. IRS Publication 523 lays out all of the details. Make sure to consult with your financial advisor to see what other strategies can be implemented to protect your assets and investments from capital gains taxes.