How to Minimize Capital Gains Tax

If you've got profit on the table and you need the money, or you want to sort of do a reset on the tax basis, just selling out of it and paying the tax is not a terrible idea because if you are paying tax, it means that you've made a profit and I would much rather have made a profit and then have to pay the tax than the alternative of not having the profit and therefore not having the tax.

Peter, very good to see you and welcome back everyone. We have a very meaty topic today, how to minimize your capital gains tax. So we're going to talk through five strategies that range from timing to charitable giving to certain investment techniques. But let's start by explaining when you are on the hook for paying capital gains tax.

What do we need to know? Yeah, basically when you make a profit off of your investments. So there are many, many, many different types of taxes that we all pay, but the big ones that people know are income tax. And then if we take some of that income and invest it, it's already been taxed once the seed has been taxed and then we invest it and it grows, that growth also gets taxed. This is where capital gains comes in. And this is where people like Warren Buffett have famously said that they pay less in taxes than their secretary. Well, that's because Warren Buffett mostly has investment income. His investments are producing growth and income, which gets taxed at the capital gains rate, which is lower than brand new income tax rates because, again, it's already been taxed once. So that's where capital gains comes in, that we need to be aware that unless we have put a specific qualification for retirement on dollars like that, it's IRA or 401K or Roth, setting those aside, if we are just investing money that we have available, it is going to be subject to capital gains when we make a profit.

Interesting. OK, so now let's talk through some strategies to minimize those taxes. The first strategy would just be bite the bullet, pay the taxes now because we are living in a low tax rate right now. Yeah, and maybe not a bad idea, but there is some advantage to holding certain investments long term. Right. As long as you don't sell and actually realize the profit, by the way, Asterix, as tax laws stand today, because they've talked about changing this. But as for right now, as long as you don't sell and actually realize the profit, then you don't owe taxes on that gain.

And the reason why they have held off on probably implementing a change that has been discussed is that this works the other way, too. As long as you don't sell, if you've got a loss, then you haven't realized that loss either. And they would have a hard time taxing people on gains that have not been sold and realized if they did not also give some caveat for. Well, what about those people who also have losses that have not been sold and realized?

And I don't think that they've figured their way through that one yet. But yeah, if you've got profit on the table and you need the money or you want to sort of do a reset on the tax basis, just selling out of it and paying the tax is not a terrible idea, because if you are paying tax, it means that you've made a profit. And I would much rather have made a profit and then have to pay the tax than the alternative of not having the profit and therefore not having the tax. Right.

All right. Next strategy would be to consider a donor advised fund. How does this help? Yeah, this is basically where you are pre gifting a legacy value, we'll call it during your lifetime. So you are creating this donor advised fund or taking part in it and making a gift where you get certain tax benefits along the way, essentially of the growth of the investment value. Plus, it's possible to also create some income with this, but it would be tax advantaged income because the dollars have been pre earmarked to go to a charity or an organization. So the donor advised fund is maybe a little bit more of an advanced strategy and possibly one that is more apt for folks that would experience estate taxes, not just income or investment tax and capital gains, but also estate taxes. But it is a great strategy for those that it does apply to or can benefit from.

All right. Another strategy would be one we've talked about before, Peter, tax loss harvesting. Right. And if you've got some winners on one hand, but on the scale of the balance of the total portfolio, you've got some losers. On the other hand, it may make sense to, again, sort of just reset things. And there are some specific time requirements here to pay attention to, but sell off both the winners and the losers, because then you can wash the gains against the losses. Hence, the term tax loss harvesting is that you are harvesting the losses so that you can offset some of the gains and not pay tax on those gains. If you don't have the gains, on the other hand, though, and sell off just the losses, there is a limit to how much you can claim and deduct from your taxable income each year.

Whereas if you have pretty significant gains on one hand, but unfortunately you have some investments that did not perform so well and you had some equally significant losses on the other hand, you can use up all of those losses in a single tax year through tax loss harvesting. Okay. We also need to make sure that we hold the asset for more than a year.

Why is that? Yeah. Hence the time requirements here, right? If you sell out and do that tax loss harvesting, you actually have to be out of the investment for a specific period of time. But in order to be qualified as a capital gain and not just income generated from your investments, you have to hold that investment for at least one year.

And there are some where you've got to hold it even a little longer than that, specifically like your primary residence. If you are looking at making a profit there, that could be a capital gain, but you need to hold that one for two years. But an investment in the market, you buy a stock or an ETF, then you've got to hold that for at least one year and one day in order to classify as a capital gain event rather than if you buy it and sell it within the year and make a profit. That's just going to be classified as income.

And by the way, there are some investments, I want to throw this caveat out there, specifically mutual funds. If you are investing after tax, non-qualified money into mutual funds, mutual funds internally can buy and sell the positions inside of the fund before that year's time has elapsed. And therefore, a mutual fund inherently can create some income tax rather than tax at a capital gain in what could potentially be realized in an alternative investment like an ETF or an individual stock. So that's something that sometimes surprises people and they are not prepared for the tax that is generated from a mutual fund.

Even if they themselves have held the fund inside the fund, there may be transactions that create a phantom gain and a tax implication for that individual. Yeah, I think we talked about that over Halloween. Yeah, phantom gains. Yeah, that's a good one over Halloween.

It's scary. All right. Last, you suggest investors consider a charitable remainder trust. Again, this one may be one that is a little bit more appropriate for the higher net worth individuals who are going to have some significant tax implications, although not exclusively. If you are charitably inclined, this could be a good way to essentially set up a contribution, a gift to a charity or multiple charities that is going to pass through the estate transition process well ahead of time. And you may receive some extra love from your favorite charity or church or organization if you set this up, but they certainly will end up receiving a wonderful gift after you're gone and you during your lifetime get some tax advantages because those funds therefore don't have the same tax implications as they would if they were just held in a non earmarked investment account. QCDs, we've talked about specifically, Aaron, qualified charitable distributions. This is kind of the same thing on maybe a smaller level for individuals that have IRA funds, right? This is different than capital gains because IRA dollars have never been taxed, not even income tax paid, remember?

But it is similar in nature to the QCD where you are gifting to a charity in order to not only benefit that charity, but get some tax benefits for yourself and for the charity as well. And by the way, again, life insurance can be a good way to provide leverage inside of these vehicles from time to time. And I know that there are specific times and places and purposes and term insurance is a great way to provide leverage for protection for your family. But if you're looking for leverage for a state or leverage and tax protection, some of the wealthiest people, some of the wealthiest families combined these strategies with a life insurance chassis because of the wonderful tax benefits that are passed along with life insurance.

Right. Well, the good news is we at least have options when it comes to trying to minimize this capital gains taxes. Peter, if somebody has questions about any of these strategies, how can they get a hold of you? Yeah, give me a call at Rashawn Planning.

We'd love to hear from you. Talk these through. Make sure you're taking steps that you are aware of all of the consequences. That's the worst thing that I've seen mistakes with capital gains is that people just didn't realize what was going to happen. So don't be surprised by your money or the taxes that are generated. Make sure you get answers and address those and give me a call.

Nine one nine three zero zero five eight eight six nine one nine three zero zero five eight eight six. You can also visit online. The website is Rashawn planning dot com.

It looks like rich on planning dot com Rashawn planning dot com. And just to kind of reiterate and emphasize here, capital gains is not going to be incurred inside of a retirement account, right? Not inside of a 401K or an IRA or a Roth.

Those are sheltered. Those have different tax implications. The conversation about capital gains is only with like a non-qualified investment that you make with what usually is more available cash. So there are more transactions a lot of times that occur inside of a non-qualified investment account.

And that's why you need to be aware, fully versed on capital gains. Okay. Peter, thanks so much for your time today. Thanks Aaron.

Hey folks, Peter Rashawn here with Rashawn planning. So glad that you are enjoying the podcast planning matters radio. You know, one of the tools that we've put out there that people really seem to appreciate and really are our finding of value is at nine one nine retired.com. It is your retirement tax bill calculator. If you've got any kind of retirement account, your tax deferred 401K or IRA, this is the website.

This is the resource where you can go. You can plug in your own numbers, your information. You can slide the tool calculator up and down for your tax rate or your amount of savings and see what your tax bill is likely to be. If you default and defer to the IRS's plan versus what you could potentially bring that tax bill down to a lot of times, it is a very significant savings. So if you have not yet go to the website nine one nine retired.com run your numbers on the retirement tax bill calculator.

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