Accelerating the Sale of Appreciated Capital Gain Property: A Strategy Worth Considering

By Jeffery Levine, IRA Technical Expert  

Follow Me on Twitter: @IRAGuru4EdSlott

As you are now no doubt aware, there are any number of ways which you might pay more in taxes for 2013 than you will this year (in case you missed it, click here to read my article on 10 of those ways). One of those many ways is when you sell long-term capital gain property. Common types of capital gain property are stocks, bonds, mutual funds and real estate. To be considered “long-term,” you must have held the investment for more than one year.

Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike), and if your unfortunate enough to get hit with the new 3.8% health care surtax as well, you could pay up to 23.8%, which is almost 60% more in tax than you would ever have to pay this year!

One of the nice things about investing though is that you can, in some ways, control your tax liability. For instance, suppose you purchased $10,000 of XYZ Corp. in your regular brokerage account several years ago. Now that stock has appreciated in value and is worth $20,000. How much tax do you owe? You might be tempted to say $1,500 (15% times your $10,000 total gain), but that wouldn’t necessarily be the case. In fact, it would only be the case if you chose to sell your investment. That’s because during the time you own a capital investment, such as a stock, bond, real estate, etc., gains and losses are generally deferred.

Most people – including most CPAs – try to put off paying taxes for as long as possible, and usually that’s a good thing. After all, isn’t that the reason so many of us contribute to a traditional IRA, 401(k) or similar type of tax-deferred account? As a result, people often hold onto investments for long periods of time. In fact, sometimes people are so averse to paying tax that they hold onto an investment long after they should, perhaps incurring investment losses that far exceed any tax they would have paid.

If, however, there was ever a time to sell appreciated property before you otherwise intended to, it could very well be now. Why not sell your long-held investment now and lock in the low 15% rate still in effect through the end of this year? Sure, you will be paying taxes before you have to, but you could be paying them at a significantly lower rate than you would in the future. In some sense, it’s
very similar to a Roth IRA conversion, where you pay taxes on your retirement account sooner than you would otherwise have to, but with the idea of locking in today’s “low” tax rates in the process.

What if you really like a stock and don’t want to be without it? No problem. You could sell your XYZ stock at 10:00 AM tomorrow to lock in the current 15% long-term capital gains rate and buy it back one minute later at 10:01 AM. You might be thinking to yourself right now, “Isn’t there some sort of rule stopping me from doing that? Don’t I have to wait more than 30 days or something like that?” If this thought is running through your mind, you’re probably thinking about the “wash sale” rule.

Fortunately, in our example, the wash sale rule doesn’t apply. The wash sale rule deals with losses, but here, we’re talking about selling investments with a gain. When/if you repurchase the same investment, your new cost basis will be the amount you paid when you repurchased it. Any future gain could still be taxed with the 20% rate – 23.8% with the surtax – but the tax would only apply to the gain above your new, higher basis.

Should you choose to take advantage of this strategy, I have one additional suggestion. Consider using non-investment money, such as money in a savings or money market account, to pay the tax. You’re probably not making much in the way of interest on those funds these days and this way, if you decide to reinvest your funds, you’re not reducing the amount to be invested by the tax you voluntarily chose to accelerate paying. You should not, however, leave yourself without enough money to meet your ongoing expenses and cover yourself in the event of an emergency.

Of course, like most planning strategies, this idea is not for everyone. Here are four groups of people who should probably not “sell early” to lock in today’s cheaper tax rates.

#1 – You expect to be in the lowest brackets in the future
If you expect your income to decrease substantially in the future, you may not want to sell your long-term capital gain property now. Although the maximum rate you could pay on the gain is 20%, plus an additional 3.8% for the health care surtax, if your income is fairly modest, you might owe as little as 10%.

#2 -You’re terminally ill
It’s hard to write about stuff like this, but it’s also an important consideration. If you are very ill and probably won’t sell your investment before you pass, you’re probably better off holding onto it. Capital assets receive what’s known as a “step-up in basis” after death. This means that whatever the value is on your date of death, that’s your heir’s new basis. So let’s assume you bought a building in 1950 for $50,000 and now it’s worth $2,000,000. If you sell the property before year-end you’re looking at close to a $300,000 tax bill. That’s better than it would be next year, but, on the other hand, assuming it’s still worth the same $2,000,000 at the time of your death, your heir could sell it for that price and pay no income tax whatsoever.

#3 – You’re never going to sell
This is really kind of an extension of #2. If you plan to hold your investment forever, there’s no point in selling now. Remember, if you never sell a capital investment, you’ll never trigger the capital gains tax, no matter how much gain you have. Plus, as noted above, when you ultimately pass those assets to your heirs, they will get a step-up in basis and may be able to sell the property on their own with little or no tax consequence.

#4 – You’re going to give it away to charity
When most people think about making charitable contributions, they usually think about donating cash or putting it on their credit card. You can, however, donate capital assets, such as stock, which in some cases may be a better move. When you donate capital assets to a charity, you don’t have to pay tax on any of the gain, plus, you get to take a charitable deduction for the full value of your investment (subject to the overall charitable contribution limits). For example, let’s say you bought ABC stock for $10,000 in 1990 and now it’s worth $110,000. If you donate that stock to charity, you’ll avoid the $15,000 ($100,000 gain x 15%) capital gains tax you would have owed had you sold the stock, plus you’ll get a $110,000 charitable contribution deduction (subject to the overall limits). The cherry on top is that for the charity, the $110,000 in stock is an equivalent donation to $110,000 since qualified charities don’t pay any income tax, including the capital gains tax on appreciated investments.

A Final Word
If you’re not one of these people, you should probably check with your tax or financial professional to see if there are other factors that may make this strategy favorable or not. Remember though, in order to lock in today’s low rates, you’ve got to sell by December 31st, so don’t wait too long, or this opportunity might pass you by.

Article Highlights:

• Currently, the maximum rate you will pay on the sale of most long-term capital gain property is 15% of the gain. Next year, that’s scheduled to jump to 20% (a 33% hike)
• Use non-investment money, such as money in a savings or money market account, to pay the tax
• Selling capital gain property is not for everyone, like if you are expecting to be in a lower tax bracket in the future, if you are terminally ill, if you are never going to sell or if you are going to give it to charity