As we take a deeper look at anticipated tax policy changes in 2021, there seems to be no doubt that this year will see a hike in the capital gains tax.
Taxpayers should not only be fully aware of these soon-to-come increases, they should also know how to prepare for them and our professional strategies to help reduce their impact.
Let’s review how your taxes on capital gains accrue and then we’ll examine various opportunities to lessen them.
The capital gains tax is one the government levies on profits made from the sale of assets such as real estate, businesses, stocks and other interests that increase in value. In other words – a capital gain is defined as when the total sale price exceeds what you originally paid for it and the ensuing tax that follows that profit.
While some lawmakers have considered taxing capital gains as regular income, effectively doubling the tax on capital gains, others have said it could even be worse. Capital gains, currently subject to a 20 percent tax for individuals earning more than $441,450, may also be subject to the 3.8 percent net investment income tax.
And, for those earning over $1 million, the capital gains tax could jump to a whopping 40.8 percent, if certain changes are adopted, financial advisors are saying. The current 20 percent, plus the 3.8 percent, plus an additional surcharge could bring the total federal capital gains tax rate to 40.8 percent.
However, there are many legal strategies that can be employed to avert, or at least reduce, your potential capital gains tax.
When it comes to real estate, there’s Section 1031 of the tax code to consider. Here, providing very specific guidelines as to timing, use of a qualified intermediary and other IRS requirements, a taxpayer is permitted to defer the payment of capital gains on investment real estate by “replacing” both debt and equity in a new real estate investment portfolio of the same, according to some tax experts.
Should a property owner decide he or she no longer wants to be a landlord, but would still like to use Section 1031, he or she may invest in a Delaware Statutory Trust investment that offers the benefit of a 1031 exchange, but as a passive investment with a professional management team in place.
Keep in mind, when applied to actively managed properties and investment in Delaware Statutory Trusts, a real estate investor can delay payment of capital gains multiple times. His/her/their heirs will receive a step-up in basis when the investor dies.
Qualified Opportunity Zones (QOZ) are another avenue to capture multiple capital gains tax benefits. By investing in real estate and businesses in under-served and distressed communities in QOZs, an investor can reinvest capital gains into Opportunity Funds that will “defer, reduce, and ultimately eliminate future capital gains.”
Other areas that can help diminish capital gains taxes include Section 121, which excludes profits from the sale of your principal residence, if the gain is less than $250,000, for a single taxpayer or $500,000, for a married couple.
For the sale of a business, Section 453 of the tax code can defer and delay capital gains taxes by putting the portion of the sale price that would have been taxed into an assortment of other beneficial investments.
Section 170, which pertains to charitable donation and tax-exempt organizations, provides for a number of incentives that can assist in reducing capital gains taxes. See our previous blog on charitable giving to learn about donor-advised funds.
In the Small Business Stocks Gains Exclusion, or Section 1202, taxpayers with capital gains from certain small business stock can avoid federal taxation, if the stock was purchased after Sept. 27, 2010 and if it’s been held for at least five years.
Another avenue for taxpayers to be aware of is Section 179. Under this provision, real estate investors can currently claim 100 percent of first year bonus depreciation or chose an accelerated, 15-year depreciation schedule for Qualified Improvement Property placed in service between 2018 and 2022.
As in all financial and tax planning matters, we encourage you to schedule a call or meeting with one of our advisors to help you review your options and make decisions that best fit your estate and tax planning needs.