Having assets increase in value is very beneficial, but it does not come without its challenges. For most assets, the increased value is subject to either individual income tax or capital gain.
Simply put, income tax is generated from your “own efforts” while capital gain results from your :investments.”
The amount of individual income tax depends on which tax bracket you are in. However, the rules for capital gains have recently become more complicated.
Until 2013, the capital gain rate was 15 percent. Now, the rate for some individuals has increased to 20 percent and there is also a new tax on “net investment income.” This tax is 3.8 percent and applies to people with incomes greater than $200,000 for a single person or $250,000 for a married couple.
The result is that selling your business, a valuable piece of real estate or stock could mean a capital gain tax of 23.8 percent being owed to the federal government—in addition to any tax at the state level.
There are ways to avoid some or all of this tax. The first step is to see a tax and estate planning professional. Some examples of advice you may receive:
- Hold the assets until your death. Upon your death, your heirs will inherit your assets with a “stepped up basis,” meaning they can sell the asset at that time and have no gain. There are also new estate planning techniques that can be used to get a stepped up basis upon the death of either spouse. Using these techniques could mean that a surviving spouse will be able to sell assets to support his or her lifestyle and avoid these taxes.
- If you are in the individual income tax bracket of 15 percent or below, you can sell stock at a zero percent gains rate. You can sell enough stock to fill that bracket each year.
- Give up to $14,000 per year to each of your heirs (depending on their tax bracket) and have them sell the asset.
- Do a 1031 exchange. This won’t eliminate taxes, but it will allow you to defer them. While mainly used for real estate, it can be used in other ways, as well.
Getting proper tax advice makes all the difference; some of these solutions can be complicated.