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Tax Strategies and Capital Gains

Part 2: Stock Portfolio Investments

Last week, we noted that we saw a significant increase in the number of clients paying tax on capital gains with a focus on selling a primary residence. This week, we will focus on capital gains related to selling stock portfolio investments.

Numerous media outlets reported stock portfolio investments hit record highs in 2021 which was the catalyst for many individuals to sell certain assets and for many funds to pay out significant capital gain distributions. In many cases, the sale of those capital assets triggered capital gain taxes.

Today’s focus will be on the tax consequences on the sale of stock portfolio investments.

Capital Assets and Taxes

The IRS defines a capital asset as follows: Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, collectibles, business property and stocks or bonds held as investments.

With any capital asset, the rate at which capital gains are taxed is based on how long you owned the asset resulting in either a short-term capital gain (owned less than one year) or a long-term capital gain. To determine how long you held the asset, you generally count from the day of acquisition up to and including the day you disposed of the asset.

Short-term Capital Gain Tax

Short-term capital gains are taxed at your marginal income tax bracket (i.e. – they have no preferential rate but are rather taxed the same as your other ordinary income). Exceptions to this rule include property acquired by gift, property acquired from a decedent or patent property.

Long-term Capital Gain Tax

If you held on to the asset for more than one year, it is considered a long-term capital asset. The below chart provides tax rates for Long-Term Capital Gains in 2022:

Filing Status0%
If taxable income does not exceed
15%
if taxable income falls between
20%
if taxable income is over
Single$41,675$41,675-$459,750$459,750
Married filing separately$41,675$41,675-$258,600$258,600
Married filing jointly (or qualifying widow(er))$83,350$83,350-$517,200$517,200
Head of Household$55,800$55,800-$488,500$488,500

The IRS lists a few exceptions on their website where capital gains may be taxed at rates greater than 20% including:

  1. The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
  2. Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
  3. The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.

Strategies to Reduce Tax Consequences

One strategy often used by investors is tax loss harvesting. Tax loss harvesting is when you sell an underperforming investment at a loss to offset the capital gains from the sale of a profitable investment. By offsetting capital gains, you may be able to lower your tax liability. There are certain rules and limitations when using a tax-loss harvest strategy. We recommend speaking with an advisor in advance of making significant transactions.

Limit on Deduction and Carryover of Losses

If your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 16 of Schedule D (Form 1040).

Capital Gain Distributions

During the current tax season, we saw many people pay significant tax on capital gain distributions.  A capital gain distribution is a payment by a mutual fund or an exchange-traded fund of a portion of the proceeds from the fund’s sale of stocks within its portfolio.  Unfortunately, these distributions are often paid very close to the end of the year and do not allow for much planning, however, you should follow your accounts and stay in touch with your broker to determine as early as possible if they anticipate you receiving significant capital gain distributions.  Hopefully, giving you enough time to act.

Net Investment Income Tax

Another area you should be aware of is if your adjusted gross income (AGI) will put you in the position of paying a surtax on your Net Investment Income (NII) in addition to the capital gains tax.

The net investment income tax is 3.8% on certain passive income including interest, dividends, gains, passive rents, annuities, and royalties. Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing StatusAGI Threshold Amount
Single$200,000
Married filing separately$125,000
Married filing jointly $250,000
Qualifying widow(er) with dependent child$250,000
Head of Household (with qualifying person)$200,000

Estimated Tax Payments

To help avoid large payments on tax day, you may also make estimated tax payments to ease the payment of capital gain taxes in April.

As always, should you have questions about this topic, or any other topics related to your personal or business situation, please contact us at any time.

Additional resources:

IRS

NIIT

Kiplinger

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