What To Do About Your Capital Gains - Part 2

In my last post we discussed some of the basics about what capital gains are, short vs. long term holding periods, and the capital gains tax rates. If these concepts are unfamiliar to you please take a moment to read Part 1 first.

Part 2: Smart ways to handle capital gains

At this point, you are considering taking some of your gains off the table. We call the act of selling the stock to lock in a gain or loss this “recognizing” your capital gains, as opposed to an “unrecognized” gain in an investment you are still holding on to. The nice thing about capital gains is they don’t show up on your tax return until they are recognized. So how can you optimize your recognized gains?

Look for losses to offset the gains

Loss harvesting is a common strategy among portfolio managers. When you sell a stock at a loss, you receive a capital loss that can offset capital gains and, to a limited extent, even offset regular income for the year. If not all your stocks were winners last year you may be able to also sell your losers to cut your tax bill.

honest work meme
Harvest those gains and losses!

How to use this information

Let’s look at an example. You (the same investor from Part 1 who bought Zoom in March 2020 and is sitting on a $315 per share gain) figured this whole coronavirus thing would be temporary and bought shares of Boeing (BA) and Carnival Cruise Lines (CCL) on March 3rd, 2020. Boeing, which you bought for $281 now trades at $200 and Carnival which you bought for $31 now trades at $19. You lost money on both of these investments. However, if you wish to sell them you can use your losses to offset, or essentially cancel out a portion of your gains in Zoom. This means a lower tax bill on your gains along with the opportunity to reinvest elsewhere.

If you are in a low income year, harvest your gains

Harvesting gains doesn’t seem to get as much attention as loss harvesting, but for the investor in the right position it can be tremendously valuable. Unfortunately, many people were laid off in 2020 and others chose (or were forced) to simply retire early.

How to use this information

Let’s revisit our Long Term Capital Gains tax brackets.

| Long Term | Long Term | Long Term | Long Term | Long Term | | :--- | :--- | :--- | :--- | :--- | | Long Term | (Single) | (Married Filing Separate) | (Head of Household) | (Married Filing Jointly | | 0% | Up to $40,400 | Up to $40,400 | Up to $54,100 | Up to $80,800 | | 15% | $40,401 to $445,850 | $40,401 to $250,800 | $54,101 to $473,750 | $80,801 to $501,600 | | 20% | Over $445,850 | Over $250,800 | Over $473,750 | Over $501,600 |

Source: Kiplinger

Of note here, filers with income in the first bracket above can potentially recognize a 0% tax rate on capital gains! You will need to work with your accountant and financial planner to see how the tax year is shaping up for you and proceed carefully. Selling too much stock could push your taxable income up into the 15% capital gains bracket. In the right circumstance selling in the 0% bracket can be a huge tax savings.

Donate your gains

Not all assets are created equally for charitable giving purposes. One of the best assets to give away is a highly appreciated stock. Once again, it is important that this is a long term holding (one year and one day!). If you are well funded on other goals, or typically give to charity but would like to consider giving stock this year instead of cash, keep reading.

How to use this information

Drawing from our earlier example, let’s again assume that you bought 50 shares of Zoom on January 3rd, 2020 for $67 per share, for a total cost of $3,350. As of today the value of the stock is around $19,100. Donating the stock instead of cash accomplishes three things:

1. You are no longer responsible for the capital gains. Neither is the charity, assuming they are properly organized and exempt from taxation.

2. You are able to give a potentially larger gift to the charity. How is that so? Let’s look at what happens if you sold the stock and donated the resulting cash. Assuming you are in a 15% capital gains tax bracket here is what happens:

| You sell the stock for a total value of $19,100 | 50 shares sold x $382 per share = $19,100 | | :--- | :--- | | Since you paid $3,350 to buy the stock, a gain of $15,750 occurs | $19,100 value - $3,350 cost = $15,750 long term capital gain | | $2,362.50 capital gains tax is due on your $15,750 gain | $15,750 gain x 15% capital gains tax rate = $2,362.50 | | Your net cash after tax is $16,737.50 | $19,100 value - $2,362.50 capital gains tax = $16,737.50 |

In this scenario, giving the stock donation allowed the same bucket of money to provide a larger benefit to the charity, as the capital gains tax is eliminated. If the gift is more than you would typically give your favorite charity in one year, consider a donor advised fund. This may all you to have your contribution recognized in one year for tax purposes, but still divide gifts out over multiple years in the future, or easily make gifts to multiple organizations from the same stock.

3. You may even receive a tax deduction for your gift. This depends on whether you itemize your taxes or not, and is subject to certain limits based on your income.

But wait! Before you sell that stock there are still some potential pitfalls and tax traps to be aware of.

Read part 3 to make sure you avoid triggering additional taxation or losing out on other benefits in the tax code

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