Are you thinking about selling a capital asset at a gain in 2013?
A 5% difference in tax rates makes a huge difference in your after-tax rate of return on an investment.
That’s how much your capital gains rate may go up in 2013. The highest rate on capital gains is now 20% – up from 15% in 2012.
And that’s not all. If you report a relatively high income, you may also be subject to an additional 3.8% Medicare tax on net investment income, including capital gains.
How do I know if I have to pay the higher tax rate?
The new 20% tax rate applies to your capital gains if you are in the new 39.6% income tax bracket.
This bracket applies if your taxable income is more than $400,000 ($450,000 if you file jointly, $425,000 if head of household, or $225,000 if married filing separately).
Do I have to pay the new additional tax on net investment income?
You may have to pay an additional 3.8% tax on net investment income – even if your income isn’t high enough for the higher capital gains tax rate.
You pay this tax if your modified adjusted gross income is $200,000 or more ($250,000 if filing jointly, or $125,000 if married filing separately). You can reduce your investment income for this tax by investment interest expense, advisory and brokerage fees, rental and royalty expenses, and state and local income taxes that you can allocate to your investment income.
This new tax applies to investment income, such as interest, dividends, capital gains, rental and royalty income. You pay it in addition to the tax you already pay on investment income.
Add the 3.8% additional capital gains tax to the new 20% capital gains tax rate, and you pay a total of 23.8% tax on capital gains – almost 10% more than you would have paid on the same sale in 2012.
How can I avoid paying the higher tax?
Now more than ever, it’s important to plan your sales of capital assets to avoid losing more of your investment gain to higher taxes.
Consider these options:
Don’t sell all at once.
Even if you’re not normally in the higher income tax bracket, one large sale can place you there for the year if you’re not careful. You might want to sell some stock one year, and wait until January to sell some more.
Take the proceeds as an installment sale.
If you have real estate you’ve been holding for 30 years, don’t let the sale bump you into the top tax bracket in the year of the sale. Consider making an installment sale. Besides saving taxes, you’ll create a steady flow of income for yourself.
Plan for a 1031 exchange.
If you sell an asset and purchase a “like-kind” property, you may qualify to put off paying tax on the gain from the first property. The idea behind this rule is that you don’t really realize a gain when you sell one asset to buy another one. Be sure to plan a 1031 exchange carefully.
Look for other ways to reduce your income tax bracket in the year of the sale.
If you’re selling a substantial capital asset at a gain, this may be a good year to sell a different asset at a loss, contribute more to charity or a retirement account, invest in your business, or take other tax saving steps.
Buy and hold.
The simplest way to put off paying tax on capital assets is to hang on to them. Perhaps the capital gain rate will come down. It’s happened before! Or you may be in a lower tax bracket in a later year, such as after you retire. In any case, you can let your investments continue to grow by simply leaving them be.