Loaded Questions: How do I reduce my capital gains exposure?

As we approach the end of the year, I’ve been hearing questions about capital gains from clients. A capital gain is incurred when you buy something low, then sell it for a higher price. Some people have really large capital gains, usually because they’ve held an asset for a long period of time. These assets could be in stock, business interests or real estate. Today we’re talking about long term capital gains on assets held over one year. A capital gain is pretty easy to understand, it’s when you buy something low and sell it for a higher price. The difference is what the IRS will tax you on.

Hi, I’m Christina Gamache, founder of Audax Wealth Management. I’m not your typical financial advisor. I don’t earn a commission on any products that I recommend because I don’t believe in having a conflict of interest. I work with business owners, women and families who need good, solid financial advice. I help clients organize their financial priorities so they can take care of the things that matter the most to them.  As a financial planner and a fiduciary, I have three thoughts that you may want to consider if you are one of these people asking this loaded question. Remember to consult your CPA or tax attorney for strategies specific to your tax situation.

First, reduce your capital gains by offsetting with capital losses. What does that mean? Well, if you have any losses in your portfolio, whether it’s real estate or stock positions or any other asset, you can try to sell those losers and offset your gains. Many investment managers, myself included, go through what’s called “tax loss harvesting” strategies to help clients reduce their tax bill.

Second, defer your capital gains to another time. You could look into strategies around gifting your asset, either “upstream” to your parents or grandparents, or “downstream” to your children. The benefit of this is that they will receive your asset and potentially get a “step-up” in cost basis. Meaning, that when you pass, your children’s cost basis will become the value of the asset on the date of your death. This value will likely be much higher than your original cost basis. They will then pay capital gains tax on the difference between the value at your date of death and the value when they sell the asset.

Another idea to defer capital gains is for high net worth investors who are qualified by their income or net worth. In 2018 the IRS declared certain areas of the country to be designated as “Qualified Opportunity Zones”. These areas are located in regions where state and federal governments wish to improve. Qualified investors could take the gains incurred from the sale of an asset and invest into these QOZs. The idea is to hold this for a long period of time, sometimes over 7 years and defer the capital gains until you are out of the QOZ. Sometimes if you hold the QOZ over 10 years, the capital gain is eliminated completely, depending on the program. https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions

Some ways you can potentially eliminate capital gains all together include a 1031 exchange or even looking into certain trusts. A 1031 exchange is where you take the proceeds of one asset and purchase similar asset within 180 days. Keep in mind that there are some strict rules about this one. One rule is that the asset must of equal or higher value if doing this. This would not work if you are trying to “downsize” your home and purchase something of lesser value, for instance. https://www.irs.gov/pub/irs-news/fs-08-18.pdf

Another idea is to talk to an estate planning attorney about possible trust strategies. There are ways to use “deferred sales trusts” or “split income trusts” that allow you to put your asset into a trust. Many times the grantors will receive some income or benefit during their lifetime, and upon their passing the beneficiaries of the trust (children, grandchildren, charities) then receive the asset itself.

So three thoughts about how reduce, defer or eliminate large embedded long-term capital gains tax. 1. Offset your gains with losses. 2. Defer your capital gains tax by gifting or considering a Qualified Opportunity Zone or 3. Look into a 1031 exchange or various trust options that would allow you to use the benefits of the asset before passing it on to a beneficiary. Remember to consult your CPA or tax attorney for strategies specific to your tax situation.

These are some complicated strategies. If you would like to talk to me about it, no charge, send me an email, give me a call, and I’m happy to walk you through this exercise and point you in the right direction.

Thank you for watching. See you next time.