Assess Your Capital Gains Treatment During End-of-Year Tax Planning

Dave Desmarais writes: Maintaining long-term assets in your portfolio is one of the most common and effective strategies for growing wealth and diversifying your investment profile. As of 2013, however, the increase in the capital gains tax rate that may apply to these assets can leave you facing larger tax liabilities than in previous years, making it imperative that you begin assessing your tax planning strategies before the year’s end.

The low 15 percent capital gains rate enjoyed by all investors last year is no longer applicable, and investors - particularly high-income earners - may now be subject to a 20 percent capital gains rate coupled with an additional 3.8 percent net investment income surtax collected to fund Medicare. One of the first steps in any detailed tax planning strategy you should take - especially as your income changes - is to determine your tax bracket, as this will directly affect your capital gains rate. Listed below are the applicable brackets and corresponding rates for the 2013 tax year.

                                                                     

Single Taxpayer	Married Filing Jointly	Capital Gain Tax Rate	Section 1411 Medicare Surtax	Combined Tax Rate
$0 - $36,250	$0 - $72,500	0%	0%	0%
$36,250 - $200,000	$72,500 - $250,000	15%	0%	15%
$200,000 - $400,000	$250,000 - $450,000	15%	3.8%	18.8%
$400,001+	$450,001+	20%	3.8%	23.8%

*The 3.8% Medicare surtax only applies to “net investment income” as defined in IRC § 1411

It’s critical for high-income investors to keep in mind, however, that even if they make more than the maximum amount for their filing status, they might still be able to take advantage of the zero or 15 percent rate, as the cutoff amounts apply to taxable income, not the larger adjusted gross income amount.

There are several investment strategies investors can implement to take advantage of lower capital gains rates, but these involve careful planning and assessing the overall performance of their stock portfolios.

Offsetting capital gains

One of the most common tactics utilized by high-income earners involves using capital losses to offset gains. Selling underperforming stocks and mutual funds that have lost value before the end of the year may help balance out any capital gains taxes imposed, while also having the added benefit of cleaning up their portfolios. This method, while effective, is not as simplified as it appears, and should first be discussed with an accountant or financial professional who can review the investor’s overall portfolio and long-term investment goals.

Investors implementing this strategy should be aware of the IRS’s “wash sale” rule.  A loss resulting from the sale or disposition of a stock, bond, mutual fund or a security is not deductible if, within a period beginning 30 days before the date of the sale and ending 30 days after the date of the sale, the individual investor acquires a substantially identical stock, bond, mutual fund or security.

Gifting appreciated property

Gifting appreciated stock to adult children or parents can also result in fewer capital gains. The Internal Revenue Service allows single filers to gift up to $14,000 to as many individuals as they wish without triggering taxes, or $28,000 for married joint filers. Donating appreciated property, rather than cash, to a qualifying charitable organization may also have two-fold benefits by enabling donors to deduct the property’s fair market value on the date it gifts and avoid paying capital gains tax on the appreciation.

Strategize through retirement accounts

Managing retirement account contributions and distributions with capital gains in mind can help reduce taxable income or secure tax-free payouts. Maxing out contributions to pre-tax retirement accounts may be enough to keep investors in the 15 percent tax bracket, which translates into a zero percent capital gains rate. If you can and do contribute to a Roth as opposed to leaving money in your non-tax-deferred brokerage account, you will avoid paying taxes on the future growth (capital or ordinary).