Episode 44 Capital Gains Tax

05/04/21 • 18 min

Profits on investments can be taxed as regular income or at a lower long-term capital gains tax rate. Capital assets are things you buy, hold, and then sell, like stocks, bonds, mutual funds, Exchange Traded Funds (ETF), collectibles, and real estate property. Its increase in value is called gain. Capital gains are taxed when they are sold. You calculate gain by subtracting what you paid, called basis, from what you sell it for. To be long term you have to hold it for one year or more. If you buy a capital asset l, hold it for one year or more, then sell it for more than you paid for it, you have a long-term capital gain. You will owe tax on it, but the tax rate you pay will be lower than regular income tax.

Long term capital gains (LTCG) are taxed at 0%, 15%, and 20%. In 2020, if your total income was up to $40,000 if you’re single, or $80,000 MFJ your LTCG are taxed at 0%! Over that up to $400,000 plus you’re LTCG will be taxed at 15%. If you are expecting a drop in income that would put you in the 0% LTCG tax bracket, like taking some time off from work after transitioning out of the military, retiring early before you are eligible for a pension or social security, or are between jobs, this may be a good time to realize a LTCG. If you sell while you are in the 0% LTCG bracket, you pay no tax on it. You can reinvest it in something else and reset your basis, paying less tax overall than if you let that initial investment ride. Even if you won’t be in the 0% LTCG bracket, the LTCG rate is always lower than your federal income tax bracket, with a couple of exceptions that I’ll cover below.

Here are a few things that are NOT long-term capital gains. Regular dividends and interest from investments you own are taxed as regular income. If you sell an asset you held for less than one year, it is a short-term capital gain and will be also taxed at your higher regular income rate.

If you sell an asset for less than you paid for it, it is a capital loss. You can subtract your losses from your gains in the same year to determine your tax. If you have an overall gain, you pay tax on the difference. If you have an overall loss of, you can deduct up to $3,000 of it from your regular taxable income. The rest of your losses have to be “carried over” to the next year.

A special category is the sale of a your home. Up to $250,000 of gain if you are single, $500,000 of gain if married is not taxed if you lived in your home for 2 of the last 5 years before you sold it. Our military can have up to 10 years to meet the requirement if you PCS . And federal employees suspend the 5-year clock while they on government orders overseas . .

There’s not enough time today to go into the sale of a rental property which is also subject to LTCG tax. But know that improvements to the property are added to basis. And when sold you will pay a special 25% capital gains tax on all the depreciation deducted from your taxes over the years, called unrecaptured depreciation.

The last special rule is the LTCG rate for some assets are taxed at a flat 28% , no matter your income . This includes collectibles like art, stamps, coins, cards, comics, other rare items, and antiques, as well as precious metals in any form. If you are a high earner in the 32%, 35%, 37% income tax brackets, the LTCG tax rate of “just” 28% is still a good deal. But for most Americans, the 28% LTCG rate for this special category of assets is HIGHER than your regular income tax rate.

Lastly, keep detailed records of how much you pay for your assets. If you are buying and selling assets with a broker-dealer, bank, or mutual fund they will issue you a FORM 1099-B each year that will list the sales details and basis and you just plug that into your tax return

IRS Topic No. 409 Capital Gains and Losses https://www.irs.gov/taxtopics/tc409

IRS Topic No. 409 Capital Gains and Losses https://www.irs.gov/taxtopics/tc409

Previous Episode

Episode 43 Save More

In Episode 39 Stash the Cash we talked about different cash accounts you can use for short term savings goals, like savings accounts, CDs, and money market accounts. Today, we’ll ask What Account Should I Consider If I Want To Save More. I put a free, handy checklist that you can download from my website at www.moneypilotadvisor.com.

Healthcare savings plans offered by employers. These aren't available to our military service members insured with TRICARE. These special savings accounts allow you to put pre-tax dollars in them directly from your pay check. And as long as you use the funds to pay eligible medical expenses, you won’t pay tax on the money when you draw it out either. With the Flexible Savings Account (FSA) you and your employer can make contributions. But remember to spend the money in your FSA each year because you can't carry it over.

Health Savings Account (HSA) You can only use one if you have a high deductible health plan. Again, not available with TRICARE. Many civilian employers and FEHB do offer them. It is like an FSA but you can carry over your balance from year to year. If you still have money in your HSA at age 65, you can withdraw it for any reason tax free. It's the Triple Crown of tax free. Consider keeping at least that max out-of-pocket amount in your HSA and/or emergency savings to cover you if you have a big expense.

Retirement savings accounts like a 401(k), 403(b), or the Thrift Savings Plan (TSP). Contribute enough to max out any match offered by your employer. For FERS employees and BRS military service members that's at least 5% of your pay. CSRS feds and non-BRS military don’t get a match. Everyone else check with your employer.

Everyone with earned income contribute to an Individual Retirement Account (IRA) and if you’re a couple with only one income, you can still save up to the max for each of you. This is a great way for a non-working spouse to build up retirement savings. There are regular r and ROTH IRAs. There’s a lot to it. Learn more in my Podcast Episodes 28, 29, and 30 .

529 College Savings Plans. 529s are offered by almost every state. Withdrawals are tax-free if used for qualified education expenses. And you can change always the beneficiary if needed. Many states also offer other incentives that sweeten the 529 pot so it's worth checking out the details for your state.

Tax Deferred Insurance either an annuity ora cash value life insurance policy, like whole life or universal life Insurance. I feel like both of these though should come with a warning label. They're not necessarily bad saving vehicles. But they often offer large commissions to the agent that sells them and all too often our sold to people when they are not appropriate. So if you're considering an annuity or cash value life insurance, this would be a great time to get a second professional opinion from a financial planner to see if other savings vehicles and or cheaper term life insurance may better fit your particular needs.

Lastly, consider a taxable brokerage account. Generally, you can take your money and use it when and where you want without a penalty. These accounts are good if you are willing to take some risk, plan to leave the money there for at least a year, and want would like to earn more return than cash accounts. Setting up these accounts doesn't have to be intimidating. You can usually set up an account online with a low fee mutual fund company like Vanguard, or Betterment which helps you invest in low cost ETFs. Even bigger name brokerage houses like Charles Schwab have some simple, low fee options. If you want someone else to handle it all for you or advice on what to invest in, this is another good time to call on a fee-only financial planner or advisor.

Next Episode

Episode 45 Rebalance

Today were going to talk about rebalancing. An investment portfolio is a group of assets you own. Ideally you have plan based on what you want that money for, when you need it, and how much risk you are willing to take in order to grow your investment. This investment plan typically includes asset allocation, which is the balance of different types investments you plan to use to achieve your goals. Invest according to your plan and you can think of your investment portfolio as “in balance”.

There are two main things that can throw your investment allocation out of balance. First, your needs and goals may change and you realize your original allocation plan doesn’t fit your new situation. You may discover you need a different portfolio allocation than you have now. You are out of balance.

One of the most common ways a good asset allocation gets out of balance is when one asset grows faster than another. Investment allocation is done by percentages. Let’s say based on your specific needs and tolerance for risk, you set your asset allocation at 50% of your investment dollars in a US Stocks, 25% in an International Stocks, and 25% in a US Bonds. Over time as your some investments grow faster than others, your allocation may drift to 55% invested US stocks, 25% International stocks, and 20% in bonds. To get back in balance, you would sell enough of your US stocks and using that to buy more bonds to bring your asset allocation back to your specific goal of 50/25/25. Keeping your risk at a level appropriate for you is the biggest benefit. Periodic rebalancing may also you earn a higher overall return. You’re selling relative winners to buy losers. And in this way you are following the mantra of successful investing – buy low and sell high.

One of the easiest ways to is to invest in a target date fund, or if your in the Thrift Savings Plan, TSP Lifecycle Funds. Typically set up in retirement accounts, all you do is choose a fund that matches the year you plan to retire. Everyone’s investment in the fund will be allocated as part of a set plan, depending on how much time you have left to retirement. The fund will do the rebalancing for you to keep your asset allocation on target. The target date fund will also gradually shift you from a relatively risky allocation to less risky allocation percentages over time.

Or you can rebalance yourself. With TSP you just is enter in your desired asset allocation percentages and TSP will do the rest. Outside TSP you may need to do some math to figure how much in dollars you need to buy and sell to get back to your target percentage. Some companies offer rebalancing tools to help you. Some offer mutual funds that maintain set asset allocations and rebalance automatically for you. Financial advisors can also help with this.

Beware, there may be tax consequences. First, if you rebalance inside a retirement account like IRAs, TSP, and 401k you don’t pay any taxes on these trades until you pull the money out, usually in retirement. But if you are rebalancing a taxable investment account, you will owe capital gains tax on investments you sell. It’s a good time to go back and listen to Episode 44 of my podcast on Capital Gains Tax. And watch the Wash Sale tax rule. It’s a bit complicated, but in general if you buy and sell the same, or nearly identical, asset within 30 days, it is also not taxed favorably. Rebalancing less often will help you avoid this altogether. And epending on where you invest, you may have to pay fees when you buy and sell. The costs can mount up.

How often? Setting time, like yearly is simplest. A second method is using tolerance bands. You do nothing when your investment allocation varies within a set range or band, like guardrails. If one asset gets out of bounds, it’s time to rebalance. This helps minimize unnecessary trading, but does require you to monitor your investments regularly.

Money Pilot Financial Advisor Podcast - Episode 44 Capital Gains Tax

Transcript

Unknown00:00:10.349

Welcome to the Money Pilot Financial Advisor Podcast, where you team up with Money Pilot founder, former Army helicopter pilot and your host Katie Cannon, and put your money where your heart is. Together, we'll tackle issues big and small so you can take charge and land your financial life.

Unknown00:00:45.030

Hello, everyone, and welcome back to the podcast. When most of us want to invest, we put our money in retire