We’ll also show you different tax-planning strategies that can significantly reduce your state capital gains tax:

• Sell appreciated assets in a Charitable Remainder Trust in order to defer capital gains.
• Buy renewable energy projects that make you eligible for significant government tax incentives that lower your capital gains tax bill. 
• Explore Oil and gas well investments that offer substantial tax benefits.
• Reduce your taxable income with charitable deduction tax strategies such as Charitable Lead Annuity Trusts.

So let’s dive in!

What are Capital Gains? 

A capital gain is a capital asset’s increase in value from the value at which it was purchased. Capital assets include stocks, real estate, crypto, and private businesses – in short, any significant property that could gain or lose value over time.

Capital gains can be realized or unrealized. Realized capital gains are gains that you have captured by selling the asset. Unrealized gains, by contrast, refer to the increase in the value of an investment that you have not yet sold. For instance, if you hold stock that increases in value, but you haven’t sold it yet, that is considered an unrealized capital gain. In general, you will not pay taxes until you cash out or “realize” the gains.

Long-Term and Short-Term Capital Gains

There are two types of realized capital gains:

• Short-term capital gains: These are gains from selling assets that you’ve held for one year or less. At the federal level, short-term capital gains are typically taxed at the same (high) rate as ordinary income.
• Long-term capital gains: These are gains from selling assets that you’ve held for more than one year. At the federal level, long-term capital gains receive more favorable tax treatment than short-term gains.

How are Capital Gains Taxed?

Capital gains are not taxed until they are realized, meaning that even if your Apple stock has increased 50x from the day you bought the stock, you won’t owe any capital gains taxes until you sell the stock. Of course, once you do sell the stock, you will face federal and (depending on the state) state taxes. The tax rate will vary depending on your income and the type of asset you sold, but the rates are generally progressive, so individuals with higher incomes tend to face higher capital gains tax rates. Let’s look at how federal and state governments tax capital gains in more depth.

Short- and long-term capital gains are taxed differently; assets held for one year or less are taxed at ordinary income rates, while longer-held assets are taxed at lower rates. 

The short-term capital gains schedule matches the schedule for ordinary income, and your marginal and effective rates depend on your income and marital status, as shown below:

Long-term capital gains, meanwhile, are taxed at a lower rate than ordinary income. Here, too, the precise rate depends on the individual’s income and marital status:

In addition, some categories of capital assets fall entirely outside of this rubric: gains on collectibles such as art, jewelry, antiques, and stamp collections are taxed up to a maximum 28% rate.

That’s not all: There’s an additional federal tax that was introduced in 2010, known as the Net Investment Income Tax (NIIT), that applies to most capital gains that exceed the exemption amount. The first $200,000 for a single filer, or $250,000 for married filers, are exempt from the NIIT. But everything in excess of those thresholds is taxed at 3.8%.

To simplify this example, let’s assume further that she doesn’t earn any other income. (If she did, it would be more complicated to figure out which bracket she falls into.) Given her $360,000 of gains, she would fall into the income bracket between $48,350 and $533,400, resulting in a long-term federal capital gains tax rate of 15%. As a result of the progressive tax system, however, not every dollar will be taxed at that rate. The amount below $48,350 won’t be taxed, so she would pay $46,748 in federal capital gains tax on this transaction (15% of every dollar over $48,350). In addition, Jenna would owe Net Investment Income Tax on the gains in excess of $200,000, resulting in another $6,080 of tax, bringing her total federal tax liability to $52,828.

• Use a Charitable Remainder Trust: You can defer capital gains by moving appreciated assets into a Charitable Remainder Trust (CRT) before you sell. A CRT is a type of trust that is for the benefit of both an individual (like you) and a charity. The individual receives distributions each year for a specified term. The charity receives a lump sum at the end of the trust term. The trust itself is tax exempt, so assets sold inside of it do not trigger any immediate capital gains tax. You pay tax on the distributions that you receive, spreading out the tax liability across many years and allowing the untaxed principal inside the trust to be generate investment returns in the meantime. CRTs can increase after-tax returns substantially. Learn more about Charitable Remainder Trusts here or set up a call with us here.
• Buy a Renewable Energy Project: Purchasing renewable energy projects can make you eligible for significant government tax incentives — tax credits and depreciation — to lower your income taxes. Taking into account tax savings and cash flow, this strategy can return 5.85x on your purchase price compared to choosing to pay your taxes directly. Learn more about renewable energy tax savings here or set up a call with us here to learn more.
• Invest in Oil & Gas Wells: These structures allow investors to put their money into the production and development of oil and gas wells. Oil and gas well investments offer substantial tax benefits, including the ability to deduct drilling costs upfront against other income, potentially recouping up to 50% of the investment in tax savings in the first year. Investors often realize 20%+ cash yields annually for the first five years. You can read more about investing in oil and gas wells here.
• Maximize Retirement Contributions: Both federal and state tax laws allow deductions for contributions to certain retirement accounts like a 401(k) or an IRA. Maxing out these contributions can lower your taxes, including ordinary income and capital gains taxes.
• Charitable Lead Annuity Trusts: If you are charitably inclined, a Charitable Lead Annuity Trust (CLAT) is an option. Like a donor advised fund, a gift to a CLAT can generate a 100% upfront income tax deduction. But unlike a donor advised fund or a typical charity, with a CLAT you can actually get a portion of your charitable gift back in the future in the form of a “remainder interest.”

You can also compare the quantitative returns and tax savings of these different strategies using our capital gains tax savings comparison calculator and customize it to your own situation.

Conclusion

Capital gain taxes can significantly reduce the wealth you keep. Fortunately, there are several strategies available to minimize these taxes. Read more here and check out our Guided Planner tool, where we’ll point you toward the strategies that might apply to you.