Protecting your assets
Strategies to deal with potential capital gains tax increases
President Biden’s proposal to raise taxes on capital gains has many investors concerned. But before you make any rash decisions with your own portfolio, it’s important to understand whether you’ll be among those affected — because not everyone will be — and if so, what steps you can take to help minimize the impact.
In addition, if you own investments you’re looking to leave to your heirs, you should also be aware of a possible change in estate tax treatment that could mean a higher tax bill for your loved ones that could be somewhat avoidable if you take action.
Managing Your Capital Gains Taxes
Before digging into the possible changes, it may be helpful to recap what capital gains taxes are. Capital gains taxes simply are taxes levied on profits from selling an investment. So, if you buy $10,000 in stock and sell those shares five years later for $20,000, you will likely owe taxes on your $10,000 capital gain, unless the investment is held in a tax-deferred account, such as a 401(k) or an IRA.
Under President Biden’s proposal, the highest tax rate for capital gains would increase to 39.6%, up from a top rate of 20% currently. But because the higher tax rate as proposed would only impact investors earning more than $1 million a year, most people wouldn’t be affected. Also, it’s important to note that the proposed changes may evolve as they move through the legislative process.
Still, if you would be impacted by this change, or are just looking to reduce your potential capital gains tax exposure, consider these actions:
Managing the Potential Elimination of Step-Up in Basis for Inherited Assets
Another potentially important change to be aware of is the proposed elimination of the step-up in basis for inherited assets. Currently, the step-up provision means that the cost basis of the inherited asset is adjusted (stepped-up) to reflect the fair market value of the asset at the time of the owner’s death. For example, if you inherited shares worth $100,000 from a deceased loved one and then sold those assets, you wouldn’t owe capital gains on that sale, even if the stock appreciated in value from an original purchase price of say $10,000.
Under President Biden’s proposal, when someone passes away, their death would trigger capital gains taxes on appreciated assets for their heirs, either at the time of death or when their heirs sell the assets. So, as with the previous example, if you inherited shares worth $100,000 that had been purchased for $10,000, you’d owe capital gains on the $90,000 worth of appreciation.
Buy-and-hold investors who own assets that have appreciated considerably in value may want to speak with an attorney or tax adviser to shrink the size of their estate. You may simply choose to realize the gains at the current lower capital gains tax rates and re-establish the basis by purchasing the same security again if the goal is to continue to hold the investments and pass them to your heirs. When repurchasing the security, be careful of the wash-sale rule, which may affect your ability to claim a deduction if you sold at a loss.
In addition, possible strategies you may want to consider include:
Revisit Your Plan with a Financial Professional
Tax laws are always evolving, and what’s proposed is often not the same as what becomes law. Regardless of what happens with taxes, consider meeting with your financial adviser. The past year has brought many developments, and it’s worth revisiting your overall plan in light of any changes COVID-19, a new administration or your personal situation may mean to your financial plan.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.
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