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All You Need to Know About Capital Gains

Candace Varner

Ben Hake

In this episode of The Standard Deduction, Tax Directors, Candace Varner and Ben Hake discuss planning, mitigating, and deferring capital gains.

The Standard Deduction podcast is hosted by Tax Directors, Candace Varner and Ben Hake. This podcast is a thoughtful, informed discussion about ideas, trends and developments in taxes related to personal wealth management.

Our mission is to educate and inspire people to make better financial choices through knowledge, tools and strategies that ensure a more prosperous future. We believe that education and planning are key components to financial success. Come explore relevant financial topics with our team.


Ben Hake: Welcome to the Standard Deduction. I’m Ben Hake.

Candace Varner: And I’m Candace Varner. We’re going to start today with some updates from our last podcast for our regular listeners, which according to the ratings has expanded past our mothers, which is good to hear. Last time, we mentioned that the tax deadline had not moved, but like all things in 2020 and 2021, these things are fluid now and they have moved the tax deadline. So the IRS and, so far I believe, all but two states have gone along with the extension. So they’re going to move the deadline for 2020 tax returns and tax payments, no penalties, no interest. You can file your return or your extension and make your payment by May 17th, 2021. Huge caveat to that, if you are one of our listeners who pays estimated tax payments, maybe you’re self-employed, maybe your withholding doesn’t keep up, a multitude of scenarios, see our episode, What’s the Deal with Withholding, but if you are someone who makes estimated payments, they did not move that deadline. So you’ll have the fun time of figuring out what you need to pay for first quarter 2021, still due April 15th. And then do it again on May 17th for your 2020 tax return because it’s fun to do a tax payment every month, I think. So as we’re finishing up these returns for 2020, Ben, what else are people asking you about?

Ben: Aside from my vacation plans after the 15th which, like the IRS’s law, is very fluid right now, they also have been asking about what President Biden’s tax proposal is and how it’s going to impact them. And so there’s been quite a few things talked about, but the big one that everyone seems to be focusing on is capital gains and possibly raising the rates for those, and how does that impact their life.

Candace: There is a lot of questions that we’re getting right now. Before we even get to his proposals and what those might do to people, let’s discuss some things that anyone can do across the board to just mitigate or plan around some capital gains.

Ben: Excellent. And so for our listeners who might not be aware, a capital gain is, generally speaking, what most people focus on is long-term capital gains. So you buy something, let’s say some Tesla shares and you hold it for a year and sell it, the IRS says, “Hey, you’re going to get a special preferential tax rate on that.” So it could be zero, 15 or 20%. I tell a lot of clients that capital gains aren’t just for high income earners, and that there’s some possibility for planning, even if you’ve got very low income. And the reason for that is, for a single taxpayer, 40 grand, and for a married couple, 80 grand, if you make that much money and some part of that is capital gains, instead of getting that 15% preferred rate, they’d drop it down to zero. So we have a number of clients who either, for whatever reason, maybe have lost a job and are trying to replace some of that cash with distributions from a brokerage account, or who have retired but haven’t hit kind of where some of that, income starts to get pushed on them like social security or RMDs.

Candace: And sometimes even if you don’t need the cash, it’s good to look in those years. Maybe we want to go ahead and just recognize some of those gains in those years because who wouldn’t want to take advantage of a 0% tax rate?

Ben: Exactly.

Candace: That’s as good as it gets. Caveat, you might still have state tax. Another one we talk to clients a lot about is for people who have real estate, and most people in real estate are aware of this, but they’re going to look at 1031 exchanges, which is basically, you’re going to take what you have. Let’s say you bought a building 20 years ago and now it’s worth significantly more, you sold it, you would have a large capital gain. But instead, if you work with a qualified intermediary and take all that cash and then not take the money personally, but instead reinvest it in another piece of real estate, you can defer that entire gain. So if you just want to move between properties or you’re being forced to sell something for some reason, that’s another way you can defer the gain so you’re not going to pay any taxes right now. Now, if you are looking to get out of real estate or you actually want the cash, that won’t work for you, but if you’re going to continue to be in real estate, that’s a good option for you.

Ben: Another item that we come up with, and it’s not for every client, but are ways that they can either exclude outright the gain, or possibly defer it with the most common ways being called a 1202 exclusion, which says, if you buy a corporate stock and you hold it for a long enough time and it’s kind of in a small enough, so 50 million or assets or less, and it doesn’t do what would normally be white collar jobs so doctor’s offices or attorneys, but if you meet all these specific criteria, the IRS will allow you to exclude up to $10 million of gain on that security. So it can be a huge tax savings. If you do it all in one year, that could be almost $2 million in tax saved. Pretty niche and very specific to what you’re invested in, so it might not be for everybody. And the other is something that just came about with the tax reform from 2018 but is the idea of an opportunity zone fund. And the idea behind that is there’s portions of the country that need economic development, so each state selected spots where if you were to take… You sold some Apple shares, you have a large gain. If you were to take your cash and invested into one of these opportunities zone funds, the IRS will allow you to defer the tax payment on that for a set number of time. So there’s some other criteria there but it might be outside the scope of our podcast, but just another opportunity for those with gains to possibly look to defer those.

Candace: The opportunity of the opportunity zone.

Ben: Exactly.

Candace: That’s nice. And finally, we have installment sales. So this one actually might be a bigger deal under Biden’s proposals. And installments sale means, let’s say, I’m going to sell my business for $50 million. I did really well. And instead, they’re not going to give me $50 million in one year, we’re going to set it up so that they give me, say, half of it upfront and the rest of it in installments over a period of years. What that does is bring my game down to a certain level in the future years, so that if there is a higher rate over a million dollars of capital gains in any given year, I can try to stay under that, or just defer the gain out to take advantage of some of those lower rates that you were talking about. So maybe I can get it down into 15% in some of those years, and over the course of time, save taxes by spreading it out. So other than those specific situations, what else could we do all the time, Ben?

Ben: One thing I tell clients about, and it’s hard to plan around, but assuming you’ve had a long enough timeline, always works, is the idea of stepping up in basis when somebody passes away. So-

Candace: You recommend that a lot?

Ben: Well, it never doesn’t happen.

Candace: That’s true.

Ben: But the idea is that under the current laws, when somebody passes away, all of their assets will get stepped up. So if you bought Tesla three months ago, or Coca-Cola 45 years ago and maybe it was only a dollar a share and now it’s worth a hundred, upon passing away, your heirs or whoever is the recipient of the inheritance would get that step up. So if they were to then immediately sell it, there wouldn’t be any gain or loss on that particular asset. Now, under Biden’s plan, there’s been discussion about changing that or the possibility that at some asset level, you wouldn’t get a step up, although nothing concrete has been discussed at this point.

Candace: And the other one that we talk a lot about at creative planning in general is tax loss harvesting, which is the idea that… Okay, so maybe you aren’t trying to sell something for cash needs but you’ve got a position that has lost money. You could sell that, realize the loss, and then buy something in a similar asset class or a similar industry, but not the exact same thing so you don’t get trapped in the wash sale rules, but you can basically harvest that loss and then keep it. So every year on your tax return, your capital losses can offset unlimited amounts of capital gains. But if you are in a net loss position, you can only use $3,000 every year. Essentially, if you have losses larger than that, you’re basically making this huge asset on your hypothetical pellet sheet of losses that you can use in a future year. So you can kind of keep accruing those for many years because one day you might need it, one day you might have that real estate you want to get out of or some other thing that you’re going to sell that’ll have a lot of capital gains, but you’ve got this kind of in your back pocket to offset a bunch of it, even in the year that it sold without doing anything else that we’ve talked about. So even if you don’t need the loss this year, it’s still a good strategy to be accruing all of those losses and carry them forward. Ben?

Ben: Well, given all those things we’ve talked about, I mean, is there any action anyone should take today?

Candace: No, absolutely not. All of those things are things you can look at in any given year, like we were talking about. All those things are not specific to binds, proposals. But specifically, when I get asked about possible tax law changes, my advice is always wait and see. If you were paying attention over the last couple of tax law changes, what they’re talking about is not going to be what’s in the law, verbatim, because there’s a big difference between what you’ll propose in a press conference or in the news, as opposed to what’s going to be in the actual signed law. And so we don’t want to make any moves, sell anything, not selling. Just don’t… Just basically just wait, and wait until it’s actually signed. There’s a lot of things that change right at the last minute in negotiations too. So we’re going to wait and see how this plays out. Luckily, if they start talking about it now, we’ve got a long time left in 2021. So there’s plenty of time to still make moves.

Ben: Perfect.

Candace: Awesome. Well, thank you.

Ben: You’re very welcome. Till next time.

Candace: Bye.

Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.

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