Estimated Read Time: 4 minutes –

Starting on Jan. 1, 2013, the top capital gains rate went from 15% to 20%. Plus, there’s a 3.8% net investment income surtax for singles earning over $200,000 and couples earning over $250,000.

The historically low capital gains tax rate of 15% is, well, history, but there are still ways around the new higher rates.  Unfortunately, the 15% top capital gains tax rate went up to 20%.   And, don’t think it won’t go higher in the future.  The rates are still very low when compared to their history.  High income earners have to tack on another 3.8% (the net investment income surtax). Look at this before year-end if you want to avoid a surprise capital gains tax bill when you file your tax returns.

For instance, on the estate planning side, an elderly client with $7 million of stock that has $6 million of built-in gain would be better off to hold onto it until death rather than sell or give it to the adult children now.  By running appreciated assets through the estate, the heirs get the assets with a step-up in basis, and no capital gains tax is due. That’s a huge deferral! Wouldn’t you rather pay 0% than 23.8% capital gains tax?

Luckily, you don’t have to die (lol) to exploit the 0% rate while you’re alive. Those in an ordinary income tax bracket of 15% or below can sell stock at a 0% gains rate.   So, often times the best strategy is not to just limit the amount of capital gain, it is to limit your ordinary income so that you limit the capital gain tax rate.

Furthermore, if you’re in a high bracket but your adult children or parents aren’t, consider giving them appreciated stock or cash. You can give $14,000 a year each to as many individuals as you would like without eating into your lifetime gift/estate tax exemption. The recipient of your stock gift takes on your basis—and later sells at the 0% rate!  This is a very basic and fundamental tax savings and estate planning strategy.

Rethinking your retirement savings strategies can also help. A young professional who’s right on the cusp of getting hit with the 3.8% surtax (for singles earning more than $200,000/couples earning more than $250,000) was making his 401(k) contributions 50% pre-tax and 50% after-tax. He’s shifted it to 75% pretax to keep him under the threshold for owing the 3.8% surtax, showing good tax planning and efficient investing.

Also, be careful not to be overly allured by the tax-free nature of a Roth. A 100% Roth 401(k) allocation only makes sense for those who expect to be in the highest marginal tax bracket indefinitely, are in the lowest tax brackets, or are in lower tax brackets today but expect to be in higher brackets when they pull the money out.

Another strategy is to ladder stock sales or exercise options over a period of time so as not to trip the top 20% rate and the surtax. And, some of our clients are increasing their exposure to municipal bonds and making oil & gas investments so as to get the intangible drilling costs as a pre-AGI deduction to keep their income below the thresholds for the taxes kicking in.

If you don’t want to change your investment mix, you can focus on simple, basic strategies like harvesting losses to offset gains. Or, take gains avoidance a step further. You can sell out of a mutual fund just before the fund manager declares capital gain payouts for the year, buy a similar exchange traded fund, and then buy back the actively managed fund.

Lastly, for those of you that like lists – Check out these strategies to bypass capital gains altogether or at least lessen the bite.

  1. Invest In Your Primary Residence. Individuals can exclude up to $250,000 of gain in their primary residence, making it one of the greatest tax shelters out there. Married couples get a $500,000 exclusion.Keep receipts of capital improvements like a new roof or kitchen faucet that add to your home’s cost basis.
  1. Manage Your Tax Bracket. If you keep your taxable income down (by stuffing pre-tax retirement accounts if you’re working, or taking no more than your required minimum distributions from your IRA if you’re retired), you can take just enough gains to stay in the 15% bracket and then your capital gains rate is 0%.
  1. Gifts To Family Members. You can make annual exclusion gifts of up to $14,000 per individual each year. If you give highly appreciated stock to your child or parent, he takes your low basis but when he sells it – if he’s in a lower bracket – his capital gains rate is 0%. (Special rules apply to kids under 25.)
  1. Gifts To Charity. Instead of selling appreciated stock and giving cash to your favorite charity, give appreciated stock. The tax benefits are twofold:  you get a deduction for the fair market value of the stock (up to 30% of your adjusted gross income), and capital gains taxes do not apply.
  1. Feed Retirement Accounts. Once you stuff after tax money into a Roth, all future growth and distributions are tax-free. Yep, that means no capital gains tax.
  1. Open A 529 College Savings Account. The money you sock away in a 529 college savings plan grows tax-free and withdrawals for education expenses are tax-free (i.e. no capital gains).  Open an account when your kids are tots, and stick to low-cost index funds.
  1. Move To A Tax-Friendlier State. State capital gains taxes take another bite—as high as 13.3% in California. If you might move to a state without an income tax, such as Florida or Nevada, consider holding off on a sale that would otherwise trigger state capital gains tax.
  1. 1031 Exchanges. This strategy is primarily for real estate investors (but it also works for artwork). You roll all the capital gains from the asset you’re selling into a new building (or artwork), which takes on the old property’s low basis. Even if rates don’t go down, you’ve had the money working for you that would have gone to pay taxes.
  1. Charitable trusts. With this type of trust, you put in $100,000 or more, and it pays out income to you for your life, with what’s left going to charity at your death. If you put appreciated assets in the trust—say a vacation home—you defer a big capital gains tax hit. If you’re in a low enough bracket when you take the payouts, you avoid the capital gains tax altogether.

As always, lowering your tax bill is about both knowledge and thoughtful, thorough planning.



Dan Lucas
Follow Me