I’m happy to say that more and more of my clients are beginning to ask about capital gains. Anyone discussing gains in this environment is a positive sign. Substantial tax savings may be derived from the current capital gains rates on certain long-term assets and qualified dividends, if acted upon with the correct timing and in the appropriate manner. This is even more important given the impending sunsetting of certain advantageous provisions of the tax code.
Generally my conversation starts with a little education on what is a capital gain, how they are taxed and when losses can be used. A capital gain results from the sale of passive investment assets generally above the purchase price or the “net tax value.” Net tax value is the purchase price minus allowable depreciation. Common types of capital gain assets are stocks, buildings or other passive investments.
Taxation of these gains generally depends not only on the type of asset but also the holding period. The most common capital gain asset is publicly traded stock. Currently, if these assets are held for one year from the purchase date they qualify for the long-term capital gain rate, 15 percent or lower depending on your tax bracket.
Other types of capital gain assets are a second home, rental property and patents. Careful attention must be given to any asset against which depreciation or amortization expenses have been taken, such as a rental building. In most instances the gain results ordinary gain, not capital gain from the recapture; ordinary gain is generally taxed at higher rates than capital gains. Additionally, there are very special rules related to certain qualified small business stock that may allow you to escape tax altogether.
One of the most common tax saving strategies for capital gains is the proper use and timing of capital losses. Since capital losses offset capital gains, it is important to time all your transactions accordingly, mainly in the same tax year. If you are holding stocks that have suffered a loss but you have not sold, consider selling these items in the same year as you sell your second residence, appreciated stocks, etc. and you can use the loss to offset the gain. If you wait until next year to sell those stocks, you may be regretting not involving your tax advisor. Oh, what a difference a day can make. The simple difference between December 31 and January 1 can cost you thousands in tax.
Let me give you an example of excellent timing. Say in year 2008, you experienced a $20,000 long-term loss from your stock investments and you used $3,000 to offset ordinary income in 2008; the remainder is carried forward to offset future gains. In 2009, your stock portfolio rebounds and on December 1 you are standing with the following appreciation in stocks that you are thinking about selling: $25,000 in Bank of America stock you bought in March, when it was at $3 (and all your friends laughed at you) and $15,000 in Microsoft that you have held for years.
If you sold these stocks you would have a $25,000 short-term gain and $15,000 long-term loss. Your long-term loss carry-forward from 2008 of $17,000 first offsets same category gain (long) and then offsets short-term. Here it would reduce the capital gain to zero, leaving $23,000 short-term gain, presuming a 34 percent tax rate the gain would result in $7,820 tax.
Alternatively, let’s say you sell the Bank of America stock in December and the Microsoft in January 2010. Here you would have $8,000 short-term gain in 2009, $2,720 in tax and $15,000 of long-term gain in 2010, $2,250 in tax. Total tax on the transaction $4,970 compared to $7,820 in tax, a savings of $2,950, that’s over 33 percent. Just by timing your sales and looking at all your holdings.
After 2010, unless new legislation is enacted by the current administration, the 15 percent capital gain rate will increase to 20 percent and qualified dividend income will be taxed at ordinary income rates.
Other items to consider: (1) A distribution or rollover from a retirement plan like a 401(k) or IRA, even though they involve stock, is not eligible for capital gains rates and must be taxed at the higher ordinary income tax rates. Remember these funds were not taxed upon entering the plan. (2) If you sell a capital asset and purchase another capital asset, this is a taxable transaction, even if you did not take possession of the funds. In most instances stocks cannot benefit from the like kind exchange rules. If conducted with advance preparation, certain real property and small business stock can receive such beneficial like kind exchange treatment and defer or possibly eliminate the assessment of tax. (3) Corporations treat capital gains differently. There is no preferential capital gains rate, all is taxed as ordinary income and the carryover period is five years. Selling of corporate assets should be closely scrutinized prior to executing.
Many have started to look for and are finding opportunities within the instability that has arisen over the recent past. I encourage you to get your trusted advisors involved early. Perhaps with the assistance of all your advisors helping to properly consult and structure transactions, you’ll find these transactions to be “less taxing” in more ways than one.
George W. Bohlé Jr. is a managing partner at Blair, Bohlé & Whitsitt, PLLC, a CPA firm that provides accounting, assurance, tax compliance and planning services, in addition to strategic planning and tax minimization strategies to privately held businesses. Contact him at 704-841-9800 or visit www.bbwpllc.com.