Strategies to reduce taxes
Here are 11 strategies for reducing taxes.
1. Manage tax brackets, harvest gains
A goal for many taxpayers is to capture the 0 percent capital gains tax rate. In 2020, a couple can have up to $80,000 in taxable income (add on the $24,000 standard deduction, and it’s over $100,000) to capture the 0 percent capital gains rate.
Next, there’s a 15 percent rate and starting at $496,600 for a couple, there’s a top 20 percent capital gains tax rate. An additional tax, called the Net Investment Income Tax, is a 3.8 percent tax on net investment income which comes into play when a couple has $250,000 or more of income. So, in practical terms, there’s also an 18.8 percent rate, and the top rate is really 23.8 percent. Also, don’t forget state capital gains taxes in your calculations.
A common strategy with investments is to sell investments that have appreciated to use up the 0 percent and/or 15 percent capital gains brackets and rebuy the same investments to reset the cost basis.
2. Harvest losses
This involves selling investments with losses in your portfolio to offset gains. If your losses are greater than your gains, you can deduct up to $3,000 a year against your ordinary income, and carry over any excess to future years.
3. DAFs for charity
With the standard deduction having been raised to $24,000 for a married couple, fewer taxpayers will itemize their deductions, which include charitable contributions.
If you are able to make two- or three-years-worth of contributions to a Donor Advised Fund (DAF), you can potentially benefit from itemizing your deductions. You can make annual grants out of your DAF to charity or let it grow and make larger donations later. Also, by donating securities or real estate to charity through a DAF, you can bypass capital gain taxes on the investment and benefit from a charitable deduction.
4. Qualified charitable distributions
If you have an IRA, you are over age 70 ½, and you make annual contributions to charity, consider making your charitable contributions through your IRA. A qualified charitable distribution is an otherwise taxable distribution from an IRA owned by an individual who is age 70½ or older that is paid directly from the IRA to a qualified charity and, yes, it qualifies as part of your required minimum deduction amount.
5. 1031 Exchange
By using a 1031 exchange on the sale of appreciated real estate, you transfer all the capital gains from the property you’re selling into a new property, which takes on the old property’s low basis, keeping money working for you that would have gone to pay taxes.
6. Charitable remainder trust
If you own appreciated securities or real estate, you can sell those assets through a charitable remainder trust (CRT) and bypass capital gain taxes on the sale. Additionally, you can sell other assets, including livestock, crops and equipment through a CRT and bypass ordinary income taxes as well.
7. Hold investments until you die
If you die with appreciated stock (including mutual funds) or real estate, your heirs get an automatic step-up in basis to its current market value at the date of your death. This enables your heirs to sell those investments after your death and avoid capital gains tax.
8. Invest in your home
Individuals can exclude up to $250,000 of gain on the sale of their principal residence if they have lived in their home for two out of the last five years. Married couples get a $500,000 exclusion. Make sure you keep receipts of improvements you make that add to your home’s cost basis.
9. College 529 plans
The money you save in a 529 college savings plan grows tax-deferred and withdrawals for qualified education expenses are tax-free. Some states also offer a tax deduction for contributions made to their state’s 529 plan.
10. Health savings accounts
If you have a qualified high deductible health insurance plan, you can make annual deductible contributions to a health savings account (HAS). The money in this account grows tax deferred and money used for qualified expenses comes out tax free. Some HSAs even allow you to invest in mutual funds.
11. Move to a tax-friendly state
If you might move soon to a state without an income tax, such as Wyoming, Florida or Nevada, consider holding off on a sale that would otherwise trigger state capital gains tax. — Chris Nolt, WLJ correspondent
(Chris Nolt is the owner of Solid Rock Wealth Management, Inc. and works with families who are selling a farm or ranch and transitioning into retirement. For more information, call 800-517-1031 or visit: www.solidrockwealth.com.)