Five Ways to Minimize a Higher Capital Gains Tax Rate

Vice President Kamala Harris has proposed a 28% capital gains tax on long-term gains — assets held for more than one year — for those making more than $100 million. The current top rate for long-term capital gains is 20%.

Her proposal would also raise the net investment income tax (NIIT) from 3.8% to 5%. Under current law, the NIIT applies to certain investment earnings once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing together.

The increases would put the all-in federal capital gains tax rate at 33%, the highest since 1978, according to the Tax Foundation. In addition, many states have their own capital gains tax, or they tax capital gains as income, like New York, California and New Jersey. Between the two, state and federal, high-income earners with unrealized capital gains may be looking at a significant tax bite.

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Of course, Harris’ tax plan would need congressional approval, which could prove difficult. Still, if you think you might be impacted by a higher capital gains tax, here are five ways we are helping our clients minimize the long-term capital gains tax:

1. Aggressive tax-loss harvesting

A time-tested way to minimize the capital gains tax is through tax-loss harvesting. Tax-loss harvesting is selling a stock, bond or mutual fund at a loss, then using that loss to offset a gain on some other position in your portfolio. You can buy back that position you sold for a loss after 30 days to avoid the wash-sale rule or purchase a like-kind security. The IRS allows investors to carry forward unused losses on your federal tax return indefinitely (state rules vary).

In practice, I find many individuals wait till the end of the year to do tax-loss harvesting, or don’t do it all. That is a wasted opportunity. The investment programs we use can harvest losses daily, sometimes weekly. The idea is a simple one, but powerful, when done correctly.

We have had clients exit positions with large unrealized capital gains, but pay very little in federal capital gains taxes simply because they banked several years of losses over time.

Be sure to use a top-rated investment program for your tax-loss harvesting — it is a technology-intensive endeavor, and not all providers are created equal.

2. Get even more aggressive with tax-loss harvesting

Tax-loss harvesting doesn’t have to happen only in bad years when stocks go down, but it can be done in good years, too. In his Journal of Investments and Wealth Monitor whitepaper The Long and Short of It, Hoon Kim of Quantinno Capital, a leader in long/short tax-loss harvesting, explains how a considerably more amount of losses can be generated from a portfolio using a long and short stock strategy vs long only.

His approach is to add an extension to an existing portfolio by borrowing against it and going long and short with a new basket of securities. This gives Kim the ability to harvest losses in good years and bad years of the stock market. (Going “long” in stocks means profiting when they go up, and “shorting” is profiting when the underlying stock goes down.) In some years, the losses generated were almost twice as much as a traditional long-only tax-loss harvesting strategy.

3. Capital gains harvesting

Capital gains harvesting is selling your winners now to take advantage of a lower capital gains rate. There are two ways to go about this. One way is to wait for your income to be lower, say, in retirement or if you are unemployed. If that’s the case, then your long-term capital gains rate could be lower as well.

Or you can choose to sell your winners now and pay the capital gains tax at current rates. If you truly think rates are going up and you want to hedge yourself, taking some chips off the table is a reasonable idea. Either way, it pays to know the capital gains tax rate and plan accordingly.

4. Spread the payment over several years

If ripping the Band-Aid off and selling all at once is too painful, a staged sale can help. A staged sale is agreeing to sell a predetermined amount each year. This can help in two ways:

• You spread your capital gains tax liability over multiple years instead of paying it all at once, which may be costly.
• If your income fluctuates, you suffer a job loss, or something else happens that puts you in a lower tax bracket, you may pay a lower longer-term capital gains tax. Be aware, you are taking a gamble by delaying — what has gone up in price, may go down, too.

5. Donate to charity

If you are charitably inclined, then consider donating appreciated stock. When you gift an appreciated stock to a charity, you can gift the stock without incurring a tax. I usually see this with clients who have a large gain in a single stock. They might be unwilling to sell the stock due to the capital gains tax. But holding a large quantity of any single stock can be risky. And if you are already gifting to charities with cash, then why not give some of the stock?

There are a few ways to gift stock. You might be able to gift directly to the charity, but I like to use a donor-advised fund, which is a great way to facilitate your giving and help with recordkeeping, a big plus come tax-filing time.

If you’re in retirement, you may use a charitable remainder trust (CRT). Here, you gift appreciated stock to the trust and avoid the capital gains tax. The trust pays you an annuity — an annual income stream for a certain number of years. The remaining assets go to the charity.

There are other ways to minimize the long-term capital gains tax. An older investor may very well hold the appreciated stock until death to take advantage of the step-up in basis (certain rules apply). This works, too — so long as Congress or the next administration doesn’t change the rules.

Or, if you plan on moving to a more tax-friendly state for retirement, maybe consider waiting to sell till after you move. Of course, you could lose money in the position while waiting, or the state could change its tax laws.

As you can see, there are many ways to reduce or eliminate a long-term capital gains tax. But what makes sense for you really depends on your situation. Consider starting with a financial plan. A financial plan is a great way to look at things in totality and help you carefully evaluate your options.

You can schedule a complimentary capital gains tax review with me here.

Michael Aloi, CFP, is an independent financial adviser with 25 years of experience in helping clients achieve their financial goals. He works with clients throughout the United States. For more information, please visit www.michaelaloi.com.

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666.

This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results.

The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

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