The end of the year is the optimal time for tax planning. It is an opportunity to look back and ahead in terms of income and expectations. This strange year has likely caused many CRE brokers to have less income than usual. Depending on your expected income this year, your marital status and household size, it could present opportunities for creative tax savings strategies. One of these strategies is called capital gain harvesting.
Investments not owned in a retirement account will have capital gains tax on the appreciation or growth of those investments when sold. If you sell an investment held for less than twelve months, you will incur short-term capital gains tax rates, which are the same as your ordinary income tax rate. However, if the investment was held for more than twelve months, you will pay long-term capital gains tax rates. Long-term capital gains tax rates are more complicated and that is where the opportunity lies.
A Single taxpayer with taxable income up to $40,000 will have a 0% tax rate on long-term capital gains. The same 0% tax rate will be had for taxable income up to $53,600 for those filing as Head of Household and up to $80,000 for Married Filing Jointly.
Taxable income is calculated after before-tax deductions like 401(k) contributions and health insurance premiums, adjustments to income like Health Savings Account contributions, standard or itemized deductions, and finally the Qualified Business Income tax deduction. This means income can be quite high and still qualify for long-term capital gains tax rates at 0%, especially for a Married Filing Jointly taxpayer.
For example, income of $150,000 less $19,500 for 401(k) contributions, $12,000 for health insurance premiums and a $7,100 Health Savings Account contribution brings Adjusted Gross Income to $111,400. Let’s assume a Standard Deduction of $24,800 and Qualified Business Income deduction of $20,000 and taxable income is now down to $66,600.
Capital gains tax rates are 0% for income up to $80,000, so there is room for realizing $13,400 of long-term capital gains and paying no taxes on those gains.
This example is oversimplified and could understate the potential top line income still eligible for the 0% tax rate because we ignored business expense deductions which can help lower income even further.
This strategy is dependent on your income and discretionary cash flow to allow for the retirement account contributions needed to help lower taxable income. This is also a situation aided by not having investments strictly in retirement accounts and why we recommend building an after-tax brokerage account.
As your income changes, so should your tax strategy. Your accountant likely will only look at this after the year has closed when preparing your tax return and this is too late. We look at this throughout the current tax year, thereby creating opportunities to help you pay less in taxes before it is too late.
