Practical Perspectives: Key Financial Issues for You and Your Family

November 2013

CATCHING UP ON CAPITAL GAINS PLANNING

Bill’s wife Evelyn scoffed at him when he decided to join an investors’ club earlier this year. But he went ahead and did it — and now, for the first time in his life, he must consider the potential impact of capital gains on his family’s tax bill. So the couple sat down with their financial adviser to catch up on the basics.

For tax purposes, their adviser began, a “capital asset” is virtually anything the couple owns or uses for personal, pleasure or investment purposes. They will incur a gain or loss whenever one of these assets is sold.

ASSETS AND BASIS

Bill admitted that he had always assumed capital gains had to do only with stocks and bonds. His adviser confirmed that they qualify, but capital assets may also include one’s home or other real estate holdings, household furnishings, and collectibles such as fine art and coins.

Essentially, whether Bill and Evelyn (or anyone, for that matter) incur a capital gain or loss starts with an asset’s “basis” — generally defined as what they paid for the asset. A gain or loss is the difference between the basis and the amount the couple receive following a sale.

LONG AND SHORT

The adviser went on to explain that the IRS breaks down capital gains into two general categories: 1) Those held a year or less are “short-term” gains and taxed at ordinary rates generally ranging from 10% to 39.6% in 2013, and 2) those held more than a year are “long-term” gains and taxed at rates of 0% for those with lower incomes, 20% for those in the highest tax bracket and 15% for everyone else.

Rates as high as 25% to 28% can apply to special types of capital gains, the adviser warned. Depending on their income, they may also have to pay an additional 3.8% unearned income Medicare contribution tax on their capital gains.

If Bill and Evelyn’s long-term gains exceed their long-term losses, the difference (called a “net long-term capital gain”) will be taxed. On the other hand, if their capital losses are greater than their capital gains, they can deduct the difference. The annual limit on this deduction is $3,000 for married joint filers or $1,500 for married couples filing separately. Excess losses can be carried over to the following year.

TODAY AND TOMORROW

Your capital gains planning begins today, their adviser told Bill and Evelyn. Starting right away and going forward, they will need to keep meticulous records, accurately identify each of their capital assets and carefully plan the timing of any sales to maximize the tax benefits.