For most people, purchasing a home is the investment of a lifetime. Homeownership reflects the achievements of decades of hard work and a life well-lived.
For many people, a home is an asset they plan to fall back on in retirement.
Imagine Mabel, a retired widow who purchased her Houston home for $23,000 in 1970. She’s on a fixed income, and with medical bills mounting, the time has come to downsize and move to a retirement community near her oldest daughter and grandchildren.
She will need the $378,000 from the sale of her home to cover her retirement expenses.
A home is considered to be a capital asset. An increase in the value of capital assets from the time of purchase until the time of sale may be taxable under the Capital Gains Tax. That means the $355,000 profit from the sale of Mabel’s home may be susceptible to a tax rate as high as 15%.
$53,250 is a significant financial loss that could drastically reduce Mabel’s quality of life in retirement.
By understanding how capital gains taxes work, you can make strategic moves to protect your assets from high taxation rates.
What Is Capital Gains Tax?
A Capital Gain occurs when you sell almost any asset for more than what you paid. This profit is then taxable under the Capital Gains Tax. Capital Gains apply to all assets, both investments and personal property.
There are two Capital Gains Tax categories: short-term and long-term. Each holds its own set of regulations and tax rates.
How Does The Capital Gains Tax Work?
The Capital Gains Tax applies to any profit from the sale of an asset.
A short-term Capital Gain would be considered any profit from an asset sold within a year of its purchase. These Capital Gains are taxed at the regular income tax rate.
A long-term Capital Gain describes profit from any sale of an asset that occurred more than a year after its initial purchase. These Capital Gains are taxed at a lower rate than regular income.
Capital Gains Tax applies to any capital asset, including but not limited to real estate, stocks, bonds, and even cars and furniture.
The Capital Gains Tax does also have several exceptions:
- The sale of a primary residence, up to a certain amount, is exempt.
- The cost of improvements to a property can be applied toward the profit
- Capital losses can be applied to the Capital Gains to offset your taxable income.
What Is The Capital Gains Tax Rate?
Short-term capital gains are taxed at the same rate as the taxpayer’s income.
Long-term capital gains, however, are taxed at a lower rate than regular income. Most individuals are taxed 15% on long-term capital gains, based on the following income brackets:
- $441,450 for a single filer
- $248,300 for married couples filing separately
- $469,050 for the head of a household
- $496,600 for married couples filing jointly
Individuals with an income that exceeds these thresholds are in a higher tax bracket.
These individuals are taxed 20% on long-term capital gains.
Those who earn $40,000 or less ($80,000 if married and filing jointly) pay 0% tax on long-term capital gains.
What Qualifies as a Capital Gains Tax Assets?
Figuring out what assets qualify and don’t qualify for Capital Gains Tax can be daunting. There are rules, regulations, and exceptions that can blur the qualification lines on different items. Examples of qualified assets include:
- Primary residency
- Household furnishings
- Silver, gold, and other precious metals
- Coin and stamp collections
- Timber grown on personal property
Luckily, not every asset owned will qualify for a Capital Gains Tax. Examples of disqualified items include:
- Inventions, designs, and patents
- Artistic and literary compositions
- Business inventory
- Accounts acquired during business transactions
Ways To Avoid Capital Gains Tax On Your Investments
You can explore many strategies to reduce your taxable income and sometimes avoid paying Capital Gains tax altogether.
Invest In An IRA or 401K
Investing in an IRA or a 401K can be a great way to reduce your taxable income. Investing in a 401K can reduce your taxable income by $19,500 per year.
You can also contribute up to $6,000 to an IRA every year. A traditional IRA allows you to reduce your taxable income by $6,000 per year if you’re under 50 and $6,500 if over 50.
Roth IRA contributions are made with post-taxed income, so it doesn’t apply here.
Gift Assets To Family
A gift is considered anything that’s given without the expectation of exchange. Gifts are allowed in the form of cash, check, or wireless transfers. Up to $15,000 per year may be given as a gift tax-free for both the giver and recipient.
Any gift exceeding $15,000 per year may be subject to a gift tax.
Donate To Charity
Donations of assets and funds to approved charitable organizations can also be applied against your taxable income. You can make tax-deductible monetary, stock, and complex asset donations and do a qualified charitable distribution directly from an IRA.
Alternative Capital Gain Reduction Strategies
Besides making moves to reduce taxable income outright, taxpayers can have several options to reduce their Capital Gains Tax bill.
Wait More Than One Year Before You Sell A Property
Real estate is where taxpayers can save the most Capital Gains tax. There are several options to consider when selling real estate to maximize available tax benefits.
Under Capital Gains, one can exclude profits from the sale of a primary residence up to a certain amount—$250,000 for individual filers and $500,000 for joint filers.
The cost of home improvements undertaken by the owners can also be applied against the taxable gains. However, it can only be invoked for primary residences once every two years.
It benefits property owners to wait at least a year before selling a property. Any Capital Assets sold within a year of purchase are taxed as regular income. This is generally much higher than the Capital Gains rate, which maxes out at 20%.
Sell Property When Your Income Is Low
Selling a property during a low-income year places you in the lower tax bracket. You’ll pay a lower income and Capital Gains Tax rate when your income is in a lower tax bracket.
Time Capital Gains With Capital Losses
Capital Gains taxes are only paid on investments once the asset is sold. They do not apply to perceived increases in value of held assets.
It’s suggested to offload profitable assets during a year when you experience Capital Losses. Any Capital Loss can be applied against the profit from selling Capital Assets. If the losses and gains cancel one another out, you’ll pay 0% tax on your Capital Gains.
Submit a 1031 Exchange
Though investment properties are not necessarily considered Capital Assets, there are still parts of the Capital Gains Tax code that can support investors.
The cost of home improvements an owner makes to a property can be applied towards the profits after the sale.
Real Estate investors can also avoid paying taxes on investment property sales by taking advantage of a 1031 Exchange. Profits from an investment property sale can be rolled into purchasing a “like-kind” property tax-free within 18 months. 1031 Exchange codes are complex, and a professional usually completes the paperwork.
Avoid Capital Gains By Investing In A Precious Metals IRA
One excellent way to avoid capital gains tax is by investing in a gold and silver IRA. No taxes will be paid on any of these holdings until they’re cashed out, just like when you invest in a traditional IRA. However, instead of investing in paper assets like stocks and bonds, you’re investing in real physical precious metals.
If you’d like to learn more about how a precious metals IRA works, you can click here to contact a member of our support team or call us at (877) 646-5347 to speak to someone immediately. Or you can click here to open an account and get started now.