By Grace S. Yung, CFP
In today’s world of volatile stock markets and the uncertain real-estate landscape, it can be tempting for investors to sell when an asset has increased in value—especially when you aren’t sure when, or if, it will ever reach that level again.
Yet, although it’s easy to visualize all the things you could do with the newfound money, the very first consideration you really need to make is how much you could be handing over to Uncle Sam. This is especially the case when you’re liquidating assets that are outside of your IRA or 401(k) retirement-plan accounts.
Tax Considerations to Consider
When selling any type of investment for more than you paid for it, you need to be aware of capital-gains taxes. The amount of your capital gain (or loss) is basically the difference between what you initially paid for the investment and what you sold it for.
So, for instance, if you paid $3,000 to purchase shares of XYZ stock, and you then sold the shares two years later for $5,000, your capital gain would be $2,000—and it is this $2,000 that you would owe tax on.
Investments Outside of Qualified Retirement Plans
When selling an investment such as a stock or a mutual fund, the amount that you pay in capital gains will also depend on how long you owned that investment. That’s because there is a difference between short-term and long-term capital gains.
You receive short-term capital gains on investments that are held and sold within a period of less than one year. Here, capital gains will be taxed at the investor’s regular income-tax rate.
However, on investments that have been held for longer than one year, long-term capital gains are taxed at a rate that depends on your income tax bracket. In 2015, the tax rate on all long-term capital gains would be 0 percent for those in the 10- to 15-percent tax brackets, 15 percent for those in the 25- to 35-percent tax brackets, and 20 percent if you are in the 39.6-percent tax bracket.
It is important to note, though, that for those who are considered “high income” individuals (singles earning over $200,000, or married-filing-jointly couples earning over $250,000), long-term capital gains will also count as qualifying income for the purpose of the 3.8 percent surtax on net investment income. In this case, the long-term capital gains rate would be an additional 3.8 percent of the rates listed above.
In addition to the sale of investments, there are other sources of income that could become taxable, including:
• Interest – The federal government treats most types of interest as if it were ordinary income. Therefore, it will be subject to whatever the marginal income tax rate that you currently pay.
• Dividends – If you receive dividends from your investments, you can get a small break here from Uncle Sam. That is because companies pay dividends out of their after-tax profits, so these funds have essentially already been taxed. Therefore, shareholders can receive a preferential tax rate of only 15 percent on the qualified dividends they receive.
Selling Real Estate: Residence versus Investment
When selling real estate, your taxes can differ depending upon whether the property is your primary residence or an investment. In most instances, the biggest asset that people own is their home—and, depending on when you purchased it and how much equity you have, it is possible that you could realize a large amount of gain when you go to sell it.
The good news here is that you may be able to exclude some—or even all—of this capital gain, provided that you meet all three of the following conditions:
• You owned the property for at least two of the years in the five-year period prior to selling it;
• The home was used as your primary residence for at least two of the years within that same five-year time period; and
• You have not excluded the capital gain from the sale of another home within a two-year period prior to the sale.
If you qualify for all of the above, then you will be able to exclude up to $250,000 of your capital gain on the sale if you are a single individual. If you are married and you file your taxes jointly, then you can exclude up to $500,000 of the gain.
Selling real estate that you’ve owned as an investment can be different—starting with how long you’ve owned the property. For instance, if you’ve owned the property for less than a year, you can be hit with a short-term capital gain—which is the same rate as your marginal income tax rate. So, for someone who is now in the 28-percent tax bracket, they’ll pay 28 percent of their gain from the investment-property’s sale.
If you’ve held your investment property for longer than a year and sell it for a gain, then your long-term capital-gains tax could range from between 0 and 15 percent, depending on what your current marginal tax rate is.
In either case, you probably have many deductions that are associated with the property that you may be able to subtract from your “tax basis.” These may help to lower the overall tax liability you owe.
Another possible strategy for deferring taxes on business or investment real estate that has appreciated is to do a “1031 exchange.” Here, you won’t be liable for any of the gain on a property that you use for business or investment, provided that it is exchanged for another “like-kind” property. According to the IRS, this basically means that the capital-gains tax won’t be charged when you sell an appreciated property if you use the funds to buy another similar one. So you could sell a four-unit rental building, purchase a similar one, and simply defer the payment of the tax until you ultimately sell your last investment property without re-investing in another one.
The Bottom Line on Selling Assets
When it comes to selling property, equities, or any other investment, the “right” time to do so will always depend on your specific situation. That’s why it is essential to work with a professional who can guide you through the process before, during, and after the actual transaction takes place.
Sales of financial assets usually have tax ramifications, and they may even encompass legal issues. With that in mind, having the right advisors on your side can help ensure that your best interests are at heart.
Personal finance-related questions may be emailed to [email protected]
Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the 2014 September issue of Texas Monthly.