What are Capital Gains?

Intro to Capital Gains Taxes

Capital gains taxes do not come from your Traditional IRA, Roth IRA, or 401k. They come from what we call “non-qualified accounts,” and you need to be aware how proposed capital gains tax rate changes will affect your legacy.

My brother Jamie is in printing. He knows more about putting ink on paper or ink on anything than pretty much anybody else I’ve ever met. He is extremely knowledgeable. Companies will hire him to ask all sorts of crazy questions and he loves to talk about it. So we get together at a family dinner and Jamie will bring up some really crazy printing term, that he thinks we all understand.

And we have no idea what the heck he’s talking about. I can’t even think of one of those terms right now. But you can see the passion in his face when he does that.

Let’s talk about a strange topic: capital gains taxes. How fun!

It sounds like a lot of fun, right? Capital gains taxes! First off let’s understand what capital gains taxes are and are not. Capital gains taxes are not inside of your Roth or Traditional IRA. And they’re not inside of your 401k. Capital gains are things inside of what we call “non-qualified accounts.”

What happens when you buy an asset, and this is true for both individuals and corporations, is that you’re going to pay a specific dollar amount. For this example let’s say you bought something for $100. You hold onto this asset for a period of time when you decide to go and sell it.

If you sell it for more than you bought it for, the transaction is considered a capital gain. So if you bought that asset for a $100 and you sold it for $150, you have a $50 capital gain.

That capital gain is taxable to you on your tax return. Not the full $150, but just that $50 gain.

When will capital gains affect me?

Capital gains come into play regarding your real estate, including your primary residence, rentals, and vacation homes. When you go to sell your property, hopefully it has increased in value. Capital gains apply to a lot of these real estate transactions.

Capital gains taxes also apply to stocks. Imagine that you bought Apple, Amazon, or any of those other crazy, high-performing stocks five or six years ago! You’d have a ton of capital gains that you’d need to worry about.

Under current tax law capital gains have a very special tax treatment, and even have their own tax rates. If your income is the lowest of the two (2) brackets, you pay a 0% tax. You could also be taxed at 15% or 20%.

Why are these low capital gains tax rates good? What do they do?

They encourage investments. The low rates encourages people to buy assets and create things.

One way that President Biden is trying to raise tax revenue is through a change in the capital gains tax structure. He wants to change some of those rates and how those assets are taxed. For the highest income earners, that capital gains rate change is going to go from 20% up to the maximum of almost 40%.

A lot of people may inherit less money.

One of the key tips and tricks that people used to use all the time is if you had a highly appreciated asset, one way to get rid of it was die with it.

If you died with it, whoever you left it to would receive a step up in basis. So let’s say you bought Apple stock for $10 and it’s now worth $500. With a step up in basis, whomever inherited this asset would have the Apple stock “purchase price” set to $500 instead of $10.

They could sell the Apple stock immediately and recognize no capital gain. They could also sell it in the future and only pay the capital gain based on that $500 limit.

Now when we’re talking about $500, it’s not really a big deal. But if you start talking about $50,000, $500,000, $1 million dollars, now we’re dealing with significant capital gains tax rates changes.

Another important thing to note is that if they eliminate that step up in basis, they’re talking about making death a “recognizable event.” Recognition is when you actually have to claim that income. Right now at death, you don’t have to claim the income. And whoever you’re passing that money on to doesn’t go on to that heir.

If death becomes a recognizable event, it now becomes a sale. And with a sale, those people are going to have to pay taxes.

A lot of people don’t care if “wealthy people” inherit less money. But if you are one of those “wealthy people,” you probably care that your children, your loved ones, the charities, etc inherit more money than uncle Sam does.

This is going to be a major tax planning topic that we’re going to have to address immediately.

Timing may be of the essence before there’s any sort of significant capital gains tax law change.

I hope you got some value out of the video we just shared with you. And if you know somebody else that could find value in this, please feel free to share it with them. If you yourself would like to talk further about this, please use the link below to book a 15 minute phone call with our office. Thanks.