t_primary-image-mobile@1/v1629389266/ZeroPercent21.jpg” srcset=”https://mediacloud.kiplinger.com/image/private/s–NYUs7dDy–/f_auto,t_primary-image-mobile@1/v1629389266/ZeroPercent21.jpg 375w,https://mediacloud.kiplinger.com/image/private/s–NYUs7dDy–/f_auto,t_primary-image-desktop@1/v1629389266/ZeroPercent21.jpg 833w,https://mediacloud.kiplinger.com/image/private/s–NYUs7dDy–/f_auto,t_primary-image-mobile@2/v1629389266/ZeroPercent21.jpg 750w,https://mediacloud.kiplinger.com/image/private/s–NYUs7dDy–/f_auto,t_primary-image-desktop@2/v1629389266/ZeroPercent21.jpg 1666w” sizes=”(max-width: 768px) 375px,(min-width: 768px) 833px,(max-width: 768px) and (min-resolution: 2dppx) 750px,(min-width: 768px) and (min-resolution: 2dppx) 1666px,375px” width=”375″ height=”211″ alt=”A man in a suit squeezes a 0% symbol.”/>
One of the greatest expenses business owners and retirees alike face is income taxes. Thats why a forward-thinking tax planner is so valuable. They can leverage the Internal Revenue Code (IRC) to lower your taxes and help you build wealth. However, theres another tax that affects business owners and investors of all types. Of course, Im referring to the capital gains tax. This tax is levied on the net gains you make when selling capital assets like stocks, businesses, land, works of art, etc.
But what if I told you, it was possible to minimize capital gains taxes to get a 0% tax rate?
In 2021, a married couple filing jointly and making below $80,800 per year (including capital gains earnings) pays no capital gains taxes. With that in the back of your mind, your goal is to reduce your familys taxable income to $80,800 or less in the years when you earn capital gains. You may think thats impossible, but its not.
7 Ways to Prepare for Higher Taxes
I have aclient who owns a small business that earned $63,000 in profits. That same year, he flipp! ed a rental house, generating an additional $30,000 in long-term capital gains. Obviously, that placed him over the $80,800 income threshold. Therefore, his tax adviser and I had to find ways to reduce his taxable income. In his case, we utilized retirement accounts and HSAs and, ultimately, got his income below the $80,800 threshold. Because of that, he paid zero taxes on the $30,000 earnings he made on the rental home he sold.
You might be able to do the same thing. There are several ways to reduce your taxable income. Speaking with your tax planner and financial adviser can help determine which methods are right for you.
Waiting to Sell
If possible, dont sell a stock or other capital asset in the first 12 months of ownership. The IRS separates capital gains into two different classifications: short-term gains and long-term gains. Selling capital assets within the first 12 months of owning them can incur ordinary income tax rates of up to 37% on their gains. However, by waiting 12 months to sell capital assets, you could incur a much lesser rate. Long-term capital gains tax rates range from 0% to 20% on your profits. Thats a significant difference!
For example, lets say you purchased a stock for $100,000 nine months ago, and its currently worth $300,000. In this scenario, you have $200,000 of earnings. By selling that stock now less than one year after youve purchased it the $200,000 of earnings would be included in your familys taxable income for the year. If your family makes $250,000 from your business and from your spouses job, then suddenly, youve earned $450,000 in income for the year, as far as the IRS is concerned. That would place you in one of the highest tax brackets there is. However, by waiting a full year to sell that same stock, you could move your income tax from short-term ordinary income to long-term capital gains tax at a much lower tax rate.
Excluding Home Sales
If youre selling your home, you may sell your primary residence ! and not p! ay taxes on up to $500,000 of your profits your capital gains as long as youre married and filing a joint tax return. However, you must have lived in the home for two of the past five years.
How You Might Save on Taxes Just by Shifting Your Investments Around
A few years ago, I had a client who bought a house in California for $500,000 as his primary residence. It is now valued at $1.5 million. Therefore, if he sells his home at its current value, he will yield $1 million in profit. However, upon the sale, he wont have to pay taxes on the first $500,000 of his capital gains. Hell only pay on the second $500,000 he made. Because that $500,000 counts as long-term capital gains rather than short-term ordinary income, he would pay around 20% on the $500,000. That comes out to about $100,000 on $1 million of gains. Thats a 10% tax bracket!
Re-balancing with Dividends
Another thing you can do to lower your capital gains tax is to re-balance your non-qualified investment accounts meaning accounts funded with after-tax money that dont qualify for special tax treatment. For instance, lets assume youve invested $100,000 in stocks and bonds. With an equal split, you place $50,000 into stocks and $50,000 into bonds. Over time, one position in the portfolio could become greater than the other due to fluctuations in the market. However, just because the market may have changed doesnt mean your risk tolerance has. Therefore, youll want to return the portfolio to its original 50/50 allocation.
To return the portfolio to its original allocation percentage, you must either sell positions that are performing well or purchase those that are under-performing. This is where potential capital gains come in. If you sell the positions that have increased in value, you will owe capital gains taxes on the money youve earned.
One way to avoid paying capital gains taxes is to divert your dividends. Instead of taking your dividends out as income to yourself, you coul! d direct ! them to pay into the money market portion of your investment account. Then, you could use the cash in your money market account to purchase under-performing positions. This allows you to re-balance without having to sell an appreciated position, generating capital gains.
Using Tax-Advantaged Accounts
You could also reduce your capital gains tax by investing in your retirement accounts and other tax-advantaged accounts, such as Roth IRAs, Roth 401(k)s, HSAs and 529 plans. Basically, youre placing money into accounts where your earnings never hit your tax returns. This ensures your gains arent subjected to capital gains tax.
Will You Run Out of Money in Retirement? The Right Income Plan Can Help
Additionally, you can place money into qualified retirement accounts, such as traditional IRAs and 401(k)s, that give you immediate tax advantages. However, you could face capital gains taxes on your earnings when you withdraw the money years down the road. But contributions you make to these accounts reduce your taxable income for that year. Remember, you wont owe capital gains taxes if your income is less than $80,800 as a married couple filing jointly. Because contributions to your IRA and your 401(k) could bring your taxable income below that threshold, this could be a viable strategy for reducing or eliminating capital gains taxes.
Using Tax Loss Harvesting
One of my favorite ways to avoid paying capital gains taxes is a strategy called tax loss harvesting. Essentially, this is where you sell investments at a loss to offset gains from other investments. For example, lets assume youve sold a stock and received $10,000 in gains. However, in the same portfolio, you have a stock that has lost $10,000. By selling that losing stock, youre able to offset the gain on which you would have paid taxes.
Its important to note that in order for tax loss harvesting to work for you, you and your tax planner have to monitor your tax liabilities throughout the year. For instance, you m! ay not ne! ed to sell losing stocks every year. Your taxable income could be below the $80,800 threshold even when earning capital gains on non-qualified investments.
On the other hand, if you and your tax adviser see that your taxable income could be above the threshold and youre earning capital gains by selling investments, tax loss harvesting might be an effective way of offsetting your gains to qualify for that 0% capital gains tax.
Carry Over Your Losses
Its possible that your capital losses exceed your capital gains. In this case, you can deduct the difference as a loss on your tax return. However, the IRS places a limit on the number of losses you can deduct each year. As of right now, a married couple filing taxes jointly can deduct up to $3,000 of capital gains losses. But what if you have more than $3,000 worth of capital gains losses one year? If this is the case, the IRS allows you to carry over the excess loss to later years.
Sometimes, planners capture significant losses for certain strategies to work. However, due to the cap, those losses cant all be written off in a single year. Thats where we use the carryover rule to claim losses for several years in a row. Yet, not all losses qualify for multi-year carryover deductions. This is another area where youll need to have a conversation with your tax and financial advisers to determine exactly which strategy is right for your individual situation.
Financial strategies to minimize your taxes can get complicated very quickly. If youre truly trying to maximize your net worth, its not always as easy as getting a booklet that tells you what to do and then filling out the booklet. Some financial planners want you to believe that. Theres a difference between working with a Wall Street broker who just wants to sell you an asset to gain a commission and working with a registered investment adviser who has a fiduciary responsibility to act in your best interest.
True financial planners, or wealth managemen! t adviser! s, realize that things like carryover losses, tax loss harvesting, contributions to retirement accounts, selling your house, and timing your asset sales make a difference in the amount of capital gains taxes you will pay and the amount of taxable income you have to claim. They will work with you to decrease your taxable income below the threshold, to help make a 0% rate on capital gains possible.
Bidens Tax Plan Could Make Marriage Penalty WorseThis article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.About the AuthorJustin Goodbread, CFP, CEPA
Founder & CEO, Financially Simple
Goodbread is a CFP, CEPA and small-business owner. His goal is to make the world of finance easy to understand. He loves digging into complex issues and explaining the details in simple terms.