There is something called a “capital gains tax” that you may have heard a few times but not really understood. At its most basic, it’s just the tax on the profit you make when you sell something that’s gone up in value.
Assets include stocks, real estate, your classic car you’ve been holding onto. Fortunately for Texans, the state is one of a handful that doesn’t get a piece of your investment profits.
But don’t get too comfortable. The federal government certainly wants a piece of the pie, even if Texas doesn’t. For those of you with substantial assets – the type of clients we work with at Dominion – it’s important to understand the ins and outs of federal capital gains tax. This isn’t a side quest you can skip; it’s a core part of keeping and growing your wealth.
Let’s break down the fundamentals of federal capital gains tax, talk about strategies to reduce your tax burden, and demonstrate how Dominion can help you take it all on with confidence. We cut through the noise and get you the facts you need.
Federal Capital Gains Tax: The Texas Perspective
OK, now that we have that out of the way, here’s how the federal government taxes capital gains. First things first, you need to know there are two categories: short-term and long-term.
Short term gains are in Assets you held for 1 year or less. It’s a fast flip, buy low, sell high, and the price is paid. Gains from these investments are taxed at the same rates as your ordinary income tax rates – up to 37%. That’s a lot.
Conversely, long-term capital gains cover assets you have owned for longer than one year. The magic occurs right here. The tax rates are much lower and top out at 20 percent for people earning the most. By virtue of being treated preferentially, this incentive is powerfully compelling for you to keep your investments and let them grow over time.
Now, let’s take a closer look at those long-term rates, because this is where it gets relevant for most of you. If you’re single and your income is over $518,900 for 2024, you’ll be in that 20% bracket.
For married couples filing jointly, that rate kicks in when their combined income tops $583,750. These numbers may sound high, but for Dominion’s clients, they’re very much within the realm of possibility.
The main point here is that federal capital gains tax is not a fixed, unchanging thing. It’s a dynamic force that influences your investment decisions. Buying or selling an asset is, in effect, a tax decision every time.
That’s why strategic planning is so important. You have to know the tax consequences of your actions and arrange your investments so that you pay as little as possible.
Still, this is not all negative news. You have proven techniques at hand for lowering your tax load and preserving your hard-earned money. Let’s talk about some of the approaches to do so in the next section.
Techniques for Minimizing Federal Capital Gains Tax
Alright, let us now discuss strategy. The game with federal capital gains tax is minimization. At Dominion, we think you have worked hard for your money and should preserve as much of it as you can. Here are some tested techniques that enable you to do precisely that:
It’s time to Play the Long Game
When we spoke about the attractive long-term capital gains rates. This is where it is useful. It’s not just a good investment strategy but a smart tax strategy as well. The advantage of using a lower tax rate on long-term gain has the potential to greatly reduce your tax burden over time. This is exactly in line with Dominion’s philosophy of wealth preservation – slow and steady wins the race.
You Have the Home Turf Advantage
It’s not just a roof over your head, it’s a tax haven. The sale of your primary home is exempted generously by the IRS. If you sell your home when you have owned and lived in the home for at least two of the five years before the sale, you can exclude up to $250,000 from your profit for single filers and $500,000 for married filing jointly. This can be a real game changer and let you upgrade your living situation without getting hammered by taxes.
The 1031 Exchange and What It Means
The 1031 exchange is a powerful tool in your arsenal if you own investment properties. With this strategy you are able to continue paying capital gains tax on the sale of an investment property as long as the proceeds are reinvested into another ‘like kind’ property, which effectively means deferring the payment of the capital gains tax. It’s a perpetual motion machine for your real estate portfolio, keeping your money working for you instead of giving it to the taxman. Of course, there are rules and timelines to follow, so you need to work with a knowledgeable advisor to make sure it goes smoothly.
Timing Is Everything: Income-Based Exemptions
You may not know that your income level can actually dictate what capital gains tax rate you pay. It’s true. Your rates, however, can be below those rates – or you may even qualify for no taxes at all on capital gains – if your income is low enough. This also includes people who have an irregular income and those about to retire. Strategically timing your asset sales, these income based exemptions allow you to use to minimize your tax liability.
The Tax-Advantaged Arsenal
These are your allies in the fight against capital gains tax: HSAs, DAFs, 529s, 401(k)s, IRAs. These tax-advantaged accounts have a number of benefits, including the potential to be exempt from capital gains tax on investments held within them. These accounts can make perfectly good sense for retirement, health care expenses, or your child’s education as part of your overall tax strategy.
These are just a few of the many strategies to minimize your federal capital gains tax liability. We join with our clients to create customized plans that meet their specific needs and goals at Dominion. We know that wealth preservation’s a process. Let’s get through it together.
Calculating Your Capital Gains Tax
Many people find great interest in the method for computing capital gains tax. Just as needed as realizing your debt is choosing wisely what will affect your bottom line. The process consists of the following phases:
Find out Your Cost Basis
This is where it all starts. The cost basis is simply what you paid for the asset, plus all fees and expenses associated with the asset. For stocks, it’s your stock price plus brokerage commissions. It covers the purchase price, closing costs and anything you have improved on the property.
Calculate the Gain
This is simple subtraction: For instance, Selling Price - Cost Basis = Gain. Let’s say you purchased a stock for $10,000 and then sold it for $15,000 – your gain would be $5,000.
Apply the Correct Tax Rate
Remember back to what were those short and long term rates we discussed? Here’s where they come in. Your gain will be subject to the appropriate rate, based on how long you held the asset. The different scenarios have different calculations. For instance:
Standard Assets
When used for stocks, bonds, and mutual funds, the above process is applicable.
Primary Residence
When you sell your primary residence, what you need to know is that you may be able to exempt the first $250,000 or $500,000–depending on who files–from capital gains.
Inherited Property
If you inherit assets, the basis of their value is “stepped up,” meaning that your cost basis will be equal to their fair market value at the time of the transfer to you. For one, this can mean a big impact on cutting your tax liability.
Investment Properties
The calculation of investment properties is similar to any other assets but depreciation and the likelihood of a 1031 exchange and deferring the taxes are topics of discussion.
Some of these calculations are simple, but the devil always is in the details. Always get professional advice if you have doubts at all, but do be sure to keep good records.
We know a lot about how complicated it can be to figure out how to report your income on your taxes, and we’ll be sure you’re just paying what you’re lawfully obligated to pay. Along the way, we’ll peek behind the curtain, make any tweaks necessary, and keep your wealth in your hands.
Lock In Your Wealth with Dominion
As we’ve seen, capital gains tax is just one part of a bigger puzzle. Our approach at Dominion is to integrate as many aspects of wealth management as we can into one package that takes a holistic approach, including tax considerations but also offers comprehensive planning of your assets to protect and grow them. So reach out today to enlist our expertise.
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