For your clients, investing in stocks or real estate can be an effective way to build wealth, but there’s a tax downside when they sell those assets. The bite taken from the profits by capital gains taxes can be sizeable, depending on the client’s income and other circumstances.
As a tax preparer, you need to understand many key points, including:
- What is capital gains tax?
- How does capital gains tax work?
- What are the differences in how it’s applied?
- Most importantly, how can you soften its sting?
Continuing professional education from a reputable provider such as Surgent Income Tax School equips you to understand capital gains tax and keep pace with changes while incorporating a few mitigating factors into your clients’ overall tax strategies to help minimize the capital gains burden.
What is capital gains tax?
The definition of capital gains taxes is written in its name. Sell a capital asset and pay a tax on the adjusted-basis profit or gains. Applicable assets include businesses, real estate, vehicles, boats and investment securities, such as stocks and bonds. Selling them triggers a taxable event that must be reported to the IRS on income taxes.
Those capital gains are classified by either a short- or long-term holding period. Short-term capital gains come from assets the taxpayer has held for less than one year, calculated from the day after acquisition up to and including the day of disposal. Long-term capital gains involve sales of assets the owner has held for one year or more. In general, the longer the taxpayer owned the asset, the less the capital gains tax will be, although a net capital gain can be determined by subtracting short-term losses for the year from long-term losses.
How does capital gains tax work?
Knowing the asset’s holding period is important because short- and long-term capital gains are taxed differently.
Short-term capital gains count as income, taxed according to the filer’s tax bracket – the sliding scale that duns taxable income anywhere from 10% to 37%. For example, say that a single client earning $85,000 a year also flips a real-estate investment in nine months, making a $30,000 profit. That $30,000 capital gain is added to the filer’s income and taxed according to the tax bracket – in this case, at 24%.
Long-term capital gains merit a much better tax break under U.S. capital gains tax rates. Single taxpayers earning up to $41,675 and married households filing jointly pay 0% so that they can keep all their profits. From there, long-term capital gains are taxed at 15% until the filer’s income reaches more than $459,750 filing single or more than $517,200 filing jointly.
What are the exceptions to capital gains tax rules?
As all tax preparers know, almost every taxable event has exceptions. When it comes to capital gains, consider these quirks in the code:
- Collectible assets: Regardless of their holding period, collectible assets are taxed at a higher rate. Collective assets include antiques, fine art, coins, or even that bottle of Chateau Lafite Rothschild prized by well-heeled wine lovers. Gains from the sale of these assets are taxed at 28%.
- Net Investment Income Tax (NIIT): The Net Investment Income Tax adds a 3.8% surtax to certain investment sales above a set threshold. It typically applies to higher-income taxpayers with significant capital gains from investment, interest and dividend income. Completing Form 8960 reveals the investment amounts subject to the NIIT.
- Real estate capital gains: Taxes on real estate capital gains, up to $250,000 individual and $500,000 married filing jointly, don’t apply to principal residences occupied for two years or more. However, capital losses from selling personal property, such as that home, are not deductible from gains.
- Retirement accounts: Capital gains and losses in retirement accounts aren’t subject to capital gains taxation.
How can you minimize your capital gains tax?
Capital gains taxes can’t be avoided, but a skilled tax preparer can help minimize the impact. Consider these tactics:
- Depreciation deductions: These deductions allow investors to account for the physical deterioration of real estate as it ages. By reducing the amount paid on the property in the first place, the buyer reaps a higher capital gain that helps recapture the taxes paid. Depreciation deduction can also apply to residences, as long as the taxpayer has owned and lived in the home for two or more of the last five years and has yet to take a primary residence exemption in two years.
- Qualifying expenses: Advise the client to track qualifying expenses in making or maintaining the investment, including travel, legal fees, repair costs and mortgage interest. They can be used for itemized deductions to increase the investment’s cost and reduce taxable profit.
- Tax-loss harvesting: Investments that lose money can be used to lessen tax liability. If the balance of gains and losses for any given year is negative, the taxpayer can use up to $3,000 of the net loss to reduce taxable income. Keep in mind that short- and long-term losses and gains can only be netted with each other – short with short or long with long. Additional losses can qualify to be carried forward to offset future capital gains. Consider advising clients about “tax-loss harvesting,” or selling a losing asset to offset the gains on another.
- Property improvements: Bump up the cost basis of real estate with property improvements, including new windows, updated appliances and floors, and upgraded systems.
- Retain your assets: Encourage your clients to retain their assets for more than one year and remind them to check their acquisition dates. A tax filer making $85,000 would have kept much more profits if they had waited three months. Warn day traders and clients who trade stocks online of higher tax liabilities for short-term capital gains. While you’re at it, make sure they are complying with the “wash-sale” rule, the IRS’ injunction against selling stock shares at a loss for the tax advantage, and then buying the same shares within 30 days.
- Retirement plans: Since retirement plans, 401(k)s and IRAs are exempt from capital gains, they are great places for tax-free investments in stocks until it’s time to withdraw. Waiting until retirement to sell capital assets can reduce the tax on capital gains if the filer’s retirement income is lower.
What is capital gains tax? As savvy investors know, it’s something to keep an eye on. In-demand tax preparers know the pathways for reducing the tax liabilities of their investments in real estate, stocks and art. Surgent Income Tax School’s robust lineup of CE courses keeps tax preparers in the know with timely updates on tax-code changes and deep dives into the tactics for minimizing your clients’ tax burdens, capital gains taxes and all other tax-related matters.
Keep your credentials current while building a repertoire of value-add skills that elevate your status in the eyes of clients. You can also visit Surgent CPE for a look at more than 1,500 webinars taught by industry-leading experts and available on your timeline.