Investors and retirement savers have many tools at their disposal to whittle their incomes down to a point where capital gains are taxed at a 0% tax rate. The magic number for couples? $83,350.
One of the greatest expenses business owners and retirees alike face is income taxes. That’s why a forward-thinking tax planner is so valuable. They can leverage the Internal Revenue Code (IRC) to suggest ways to lower your taxes and help you build wealth. However, there’s another tax that affects business owners and investors of all types. Of course, I’m referring to the capital gains tax. This tax is levied on the net gains you make when selling capital assets like stocks, businesses, land, works of art, etc.
But what if I told you, it was possible to minimize capital gains taxes to get a 0% tax rate?
In 2023, a married couple filing jointly and making below $83,350 per year (including capital gains earnings) pays no capital gains taxes. With that in the back of your mind, your goal is to reduce your family’s taxable income to $83,350 or less in the years when you earn capital gains. You may think that’s impossible, but it’s not.
I have a client who owns a small business that earned $63,000 in profits. That same year, he flipped a rental house, generating an additional $30,000 in long-term capital gains. Obviously, that placed him over the $83,350 income threshold. Therefore, his tax adviser and I had to find ways to reduce his taxable income. In his case, we utilized retirement accounts and health savings accounts (HSAs) and, ultimately, got his income below the $83,350 threshold. Because of that, he paid zero taxes on the $30,000 earnings he made on the rental home he sold.
You might be able to do the same thing. There are several ways to reduce your taxable income. Speaking with your tax planner and financial adviser can help determine which methods are right for you.
Wait for 12 Months to Sell
If possible, don’t sell a stock or other capital asset in the first 12 months of ownership. The IRS separates capital gains into two different classifications: short-term gains and long-term gains. Selling capital assets within the first 12 months of owning them can incur ordinary income tax rates of up to 37% on their gains. However, by waiting 12 months to sell capital assets, you could incur a much lower rate. Long-term capital gains tax rates range from 0% to 20% on your profits. That’s a significant difference!
For example, let’s say you purchased a stock for $100,000 nine months ago, and it’s currently worth $300,000. In this scenario, you have $200,000 in earnings. By selling that stock now — less than one year after you’ve purchased it — the $200,000 of earnings would be included in your family’s taxable income for the year. If your family makes $250,000 from your business and from your spouse’s job, then suddenly, you’ve earned $450,000 in income for the year, as far as the IRS is concerned. That would place you in one of the highest tax brackets there is. However, by waiting a full year to sell that same stock, you could move your income tax from short-term ordinary income to long-term capital gains tax at a lower tax rate.
Home Sales Excluded, With Limits
If you’re selling your home, you may sell your primary residence and not pay the capital gains tax on real estate on up to $500,000 of your profits – your capital gains – as long as you’re married and filing a joint tax return. However, you must have lived in the home for at least twenty-four months within the previous five-year period.
A few years ago, I had a client who bought a house in California for $500,000 as his primary residence. It is now valued at $1.5 million. Therefore, if he sells his home at its current value, he will yield $1 million in profit. However, upon the sale, he won’t have to pay taxes on the first $500,000 of his capital gains. He’ll only pay on the second $500,000 he made. Because that $500,000 counts as long-term capital gains rather than short-term ordinary income, he would pay around 20% on the $500,000. That comes out to about $100,000 on $1 million of gains. That’s a 10% tax bracket!
Rebalance Non-Qualified Investment Accounts With Dividends
Another thing you can do to lower your capital gains tax is to rebalance your non-qualified investment accounts — meaning accounts funded with after-tax money that don’t qualify for special tax treatment. For instance, let’s assume you’ve invested $100,000 in stocks and bonds. With an equal split, you place $50,000 into stocks and $50,000 into bonds. Over time, one position in the portfolio could become greater than the other due to fluctuations in the market. However, just because the market may have changed doesn’t mean your risk tolerance has. Therefore, you’ll want to return the portfolio to its original 50/50 allocation.
To return the portfolio to its original allocation percentage, you must either sell positions that are performing well or purchase those that are underperforming. This is where potential capital gains come in. If you sell the positions that have increased in value, you will owe capital gains taxes on the money you’ve earned.
One way to avoid paying capital gains taxes is to divert your dividends. Instead of taking your dividends out as income to yourself, you could direct them to pay into the money market portion of your investment account. Then, you could use the cash in your money market account to purchase underperforming positions. This allows you to rebalance without having to sell an appreciated position, generating capital gains.
Investing in Tax-Advantaged Accounts
You could also reduce your capital gains tax by investing in your retirement accounts and other tax-advantaged accounts, such as Roth IRAs, Roth 401(k)s, HSAs, and 529 plans. Basically, you’re placing money into accounts before the earnings hit your tax returns.
Additionally, you can place money into qualified retirement accounts, such as traditional IRAs and 401(k)s, that give you immediate tax advantages. However, you could face capital gains taxes on your earnings when you withdraw the money years down the road. But contributions you make to these accounts reduce your taxable income for that year. Remember, you won’t owe capital gains taxes if your income is less than $83,350 as a married couple filing jointly. Because contributions to your IRA and your 401(k) could bring your taxable income below that threshold, this could be a viable strategy for reducing or eliminating capital gains taxes.
Tax Loss Harvesting Can Save on Taxes
One of my favorite ways to reduce capital gains taxes is a strategy called tax loss harvesting. Essentially, this is where you sell investments at a loss to offset gains from other investments. For example, let’s assume you’ve sold the stock and received $10,000 in gains. However, in the same portfolio, you have a stock that has lost $10,000. By selling that losing stock, you’re able to offset the gain on which you would have paid taxes.
It’s important to note that in order for tax loss harvesting to work for you, you and your tax planner have to monitor your tax liabilities throughout the year. For instance, you may not need to sell losing stocks every year. Your taxable income could be below the $83,350 threshold even when earning capital gains on non-qualified investments.
On the other hand, if you and your tax adviser see that your taxable income could be above the threshold and you’re earning capital gains by selling investments, tax loss harvesting might be an effective way of offsetting your gains to qualify for that 0% capital gains tax.
You Can Carry Over Some of Your Losses
It’s possible that your capital losses exceed your capital gains. In this case, you can deduct the difference as a loss on your tax return. However, the IRS places a limit on the number of losses you can deduct each year. As of 2023, a married couple filing taxes jointly can deduct up to $3,000 of capital gains losses. But what if you have more than $3,000 worth of capital gains and losses in one year? If this is the case, the IRS allows you to carry over the excess loss to later years(opens in a new tab).
Sometimes, planners capture significant losses for certain strategies to work. However, due to the cap, those losses can’t all be written off in a single year. That’s where we use the carryover rule to claim losses for several years in a row. Yet, not all losses qualify for multiyear carryover deductions. This is another area where you’ll need to have a conversation with your tax and financial advisers to determine exactly which strategy is right for your individual situation.
Financial strategies to minimize your taxes can get complicated very quickly. If you’re truly trying to maximize your net worth, it’s not always as easy as getting a booklet that tells you what to do and then filling out the booklet. Some financial planners want you to believe that. There’s a difference between working with a Wall Street broker who just wants to sell you an asset to gain a commission and working with a registered investment adviser who has a fiduciary responsibility to act in your best interest.
True financial planners, or wealth management advisers, realize that things like carryover losses, tax loss harvesting, contributions to retirement accounts, selling your house, and timing your asset sales to make a difference in the amount of capital gains taxes you will pay and the amount of taxable income you have to claim. They will work with you to decrease your taxable income below the threshold, to help make a 0% rate on capital gains possible.