Brace for Long-Term Capital Gains Tax IncreaseSubmitted by Grunden Financial Advisory, Inc on March 25th, 2010
When President Bush passed tax cuts in 2003 and 2006, the long-term capital gains rate decreased from 20% to 15% for a specified period of time. These rates applied to investors in the 25% tax bracket or above. For investors in the 10% to 15% tax bracket, the long-term capital gains rate is actually 0%. We are now approaching the end of those tax cuts this year and are faced with potentially higher capital gains rates than before.
Most assets held one year or longer currently qualify for the 15% long-term capital gains rate (or 0% tax rate if in a low tax bracket). After 2010, however, the law reverts back to the previous tax rate of 20%. What’s more, President Obama’s administration may push to tack on an extra 2.90% for Medicare on top of the new 20% rate to help pay for health-care initiatives.
If the long-term capital gains tax resets to 20% and the new Medicare tax of 2.9% is added on, many investors face a 53% tax rate increase on qualified assets (15% vs. 22.9%). Even if the Medicare tax isn’t added on, the increase still represents a 33% tax rate increase (15% vs. 20%).
There are a few planning strategies available to those who wish to minimize taxes. For investors who owned the same stock(s) for one year or more, it maybe to their benefit to use the lower tax rates in 2010 to sell the stock(s) and invest in a more diversified portfolio. Saving 53% in taxes is a nice incentive to make a change.
Another strategy for investors in the 10% to 15% tax bracket maybe to sell some of their stocks/mutual funds with gains then buy the same securities back. This will reset the basis to today’s value and avoid paying any long-term capital gains tax.
Investors with real estate holdings also stand to benefit if sold in this year. The long-term capital gains rate of 15% today also applies to these assets. For example, if a home owner sells their home on December 31, 2010 and captures a gain of $1,000,000 (after the home exclusion amount), the tax due is $150,000. If the same house is sold one day later, on January 1, 2011, the tax due may be as much as $229,000…a difference of $79,000 in taxes.