This article originally appeared in the February 2024 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.
When you invest your money, the hope is that over time the asset will grow, or appreciate. That capital asset can be stock or a house or even a piece of art.
But an investor might find that tapping that appreciation could trigger some significant financial consequences. “The one thing to be concerned about is pushing yourself into a higher tax bracket,” said Kathleen Buchs, CPA, managing director at MAI Capital Management.
It’s important to understand the nuances of appreciated capital assets, which carry some special tax rules. Furthermore, there are strategies that can help you minimize the financial effects; read on to learn more about some strategies that might be useful to you.
As you head toward Medicare eligibility, planning for appreciated capital assets becomes more critical because you don’t want to be hit with this nasty surprise: Selling a capital asset with a hefty gain could spike your Medicare premiums for Part B and Part D into the stratosphere. Preparing your retirement financial plan with this in mind might help you mitigate the pain or avoid that surprise altogether.
Prepare for Medicare Premiums
As you approach your 60s, it’s not just taxes to worry about when you sell appreciated assets but also the impact on your Medicare costs. Higher income can trigger an Income-Related Monthly Adjustment Amount (IRMAA) that is added to your Medicare premiums. This is “one of the reasons
why establishing a plan to take gains is critical,” said Navy veteran James Bailey, CFP®, senior wealth advisor and portfolio manager at Exencial Wealth Advisors.
A key step is to brush up on the rules for Medicare Part B and Part D premiums. Instead of getting hit with IRMAA by surprise, understanding the rules can help you plan so you might avoid or lower the surcharge.
Medicare eligibility starts at age 65, but planning for Medicare premiums should begin at least by age 63. Whether you pay IRMAA is based on income information from your tax return from two years prior — the latest information the federal government has.
IRMAA starts for single filers who have income above $103,000 in 2024 and for joint filers who have income above $206,000. While the standard monthly Part B premium in 2024 is $174.70, IRMAA can make that premium climb from $244.60 to $594.00, depending on your income. For Part D, the surcharges will tack on an extra $12.90 to $81.00 to your 2024 plan premium each month. Go to Medicare.gov to see the IRMAA income brackets; note that most military retirees don’t need to worry about Part D because of having TRICARE pharmacy coverage.
As retirement nears, consider your financial plans. You might want to whittle down appreciated holdings over a series of years, for instance, or decide to include those appreciated assets in your estate plan instead of using them during your lifetime.
If you get hit with IRMAA, consider appealing the surcharges by filing Form SSA-44. Reasons such as divorce or death of a spouse, or even retirement, can help you avoid the surcharges if your current income is lower than when you filed your tax return two years ago. But selling your house or a stock at a hefty profit won’t excuse you from paying Part B and Part D premium surcharges.
There is a silver lining: If the capital gains are incurred in only one tax year, your premium surcharges will also last only one year. If your income drops the next tax year, the premiums based on that tax information will also drop.
Here’s how to bring the shine back to owning assets that have a bounty of growth.
Rates as Low as Zero
The good news for capital gains: Appreciated assets held for longer than a year qualify for lower federal income tax rates than ordinary income, even as low as 0%. That’s a bargain that’s hard to beat!
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To grab the 0% tax rate, a single taxpayer can have taxable income up to $47,025 for 2024 and a married couple filing jointly can have taxable income up to $94,050 for 2024. If you expect your income to fall after retiring, you might be able to keep your income in the 0% tax rate territory. Evaluate your tax situation for a few years when doing your tax planning — perhaps by pushing or pulling income or deductions into one tax year, you could take advantage of the 0% rate one year, if not every year. “Look for a low income year to recognize gains,” Buchs said.
Taxable income is reduced by deductions, whether you itemize or take the standard amount. For example, a married couple filing jointly who are both age 62 can take a standard deduction of $29,200 for 2024. So this couple could potentially shelter up to $123,250 of capital gains for 2024 if they had no other taxable income. Any other taxable income, such as military retirement pay, would count toward that income limit and determine whether or not a taxpayer can stay in that 0% threshold for capital gains.
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If you can’t qualify for the 0% tax rate, all is not lost. You can still qualify for tax rates lower than ordinary income tax rates:
- 15% Rate: Taxable income from $47,026 to $518,900 for single filers, $94,051 to $583,750 filing jointly.
- 20% Rate: Taxable income above $518,900 for single filers, above $583,750 filing jointly.
Remember, if you sell assets held for a year or less, ordinary income tax rates apply to short-term gains instead of the more favorable long-term rates.
The capital gains tax rate for art and collectibles is higher — a maximum 28%. IRS Publication 550, Investment Income and Expenses, has more details on capital gains tax rules.
Don’t forget about state tax ramifications, said Buchs. “Every state is different,” she said. Check your state tax rules, and be sure to factor that into your tax planning.
Of course, taxes aren’t the only factor to think about when selling assets from a portfolio. Consider your overall investing and financial planning goals.
“Historically, capital gains tax rates are low,” said former Petty Officer 3rd Class James Bailey, USN, CFP®, senior wealth advisor and portfolio manager at Exencial Wealth Advisors. “With that in mind, don’t let the tax tail wag the investment dog.”
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Tax planning tip: If you sell an appreciated stock, but it’s a stock you like, you can always buy new shares. The basis for those shares will be the higher current market value, which any future appreciation would be based on. So if you sell appreciated shares at a 0% tax rate, you’ve locked in gains at 0%, while raising the basis for future gains. Unlike with capital losses, there is no wash-sale rule for gains. You could buy the same shares immediately after selling with no consequence.
Donating Appreciated Assets
If you are charitably inclined, one way to mitigate the tax bite on capital gains is to donate appreciated assets to charity. You get a charitable deduction based on the value of your gift and pay no tax on the appreciation, and the charity of your choice receives the gift free of tax. Donating appreciated assets “helps the charity and helps you out — it’s a win-win situation,” said Bailey.
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If you aren’t sure which cause or charity you want to support, you can donate appreciated assets to a donor-advised fund. This allows you to take the tax deduction for the current tax year, while allowing you to direct the money to charities of your choice in the future.
Tax planning tip: Individual retirement account (IRA) owners who are age 70½ or older can give up to $105,000 to charity in 2024 through qualified charitable distributions, or QCDs, from their IRAs directly to charities of their choice. While those distributions would have been taxed at ordinary income tax rates, older taxpayers might consider giving to charity through their IRA and holding on to their appreciated assets. Run the numbers to see which strategy works best for your situation.
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Home Profit Exclusion
Where you live isn’t just home sweet home; it’s also a capital asset if you own it. Unlike appreciated stock, which you can sell over a period of time to mitigate taxes, “you can’t do that with a home, which is often the most valuable asset,” said former Lt. Jean Wilczynski, USCG, CFP®, senior wealth advisor at Exencial Wealth Advisors.
If you’ve lived in your home for years or in an area that has had a frothy housing market, you might be sitting on a lot of equity. And if you sell, that appreciation might become taxable. Another piece of good news: There is an exclusion for home sale profit.
Generally, if you own and live in your home for 24 months out of the past five years, an individual filer is eligible to exclude up to $250,000 of home sale profit from tax and married couples filing jointly can exclude up to $500,000 of home sale profit. The 24 months “doesn’t have to be consecutive,” Wilczynski said.
Servicemembers on active duty get an even bigger window to qualify for the exclusion, and it’s often overlooked, said Buchs, whose husband, father, and
grandfather served overseas.
“There is a stop-the-clock exemption for military; active duty get to look out over 15 years,” instead of five years, she said. That 15-year time frame applies to members of the uniformed services who are on qualified extended duty. For more on the exclusion rules and the break for active duty servicemembers, read IRS Publication 523, Selling Your Home.
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If you have lived in your home for a while, your profit might exceed that exclusion amount, particularly if you live in a housing market that has gone bonkers in recent years. You’ll owe tax on the profit that exceeds the exclusion amount, but the taxable appreciation qualifies for the lower, long term capital gains tax rates.
Tax planning tip: Keep good records of what you pay for improvements to your home. Those costs can be added to your home’s original cost basis when you sell. An increased basis can help you protect more of your home sale profit from taxes.
Harvest Tax Losses
When it comes to investments owned in a brokerage account, tax losses might become your friend. Investors generally don’t like to see red in their accounts, but if you hold some losers, you can turn those lemons into lemonade by harvesting capital losses.
You can use those losses to offset capital gains and up to $3,000 in ordinary income in one tax year, and any excess tax losses can be carried forward into future tax years. Losses aren’t locked in until you actually sell the investment, of course.
“We look for opportunities throughout the year and especially at year-end,” Wilczynski said.
Waiting closer to the end of the tax year to harvest losses gives you a better idea of your tax situation for the year. You might also consider harvesting losses as part of rebalancing your portfolio so that your allocated targets are recalibrated in line with your financial plans.
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Tax planning tip: If you sell a stock at a loss but think it might still have potential, be careful about when you buy it back. Do so in less than 30 days, and you can trigger the wash-sale rule, which can disqualify your tax losses and blow up this strategy. The rules are complicated, so it can be a good idea to consult a tax advisor when harvesting losses.
Basis Step-Up
A final tax-saving strategy: Hold on to appreciated assets until you die. At your death, any appreciation on a capital asset, such as a stock or your home, will “step up” to the market value on the date of your death.
If you bought your house at $200,000 and it’s worth $1 million the day you die, your heirs will receive the $800,000 of appreciation tax-free. Own a stock that has $500,000 in appreciation? That transfers to heirs tax-free if you still own it at your death. Only future growth on the new, higher basis will be taxable for heirs.
This holding strategy is surely simple, but do think it through. For example, with shares, “the big risk is if something happens to the company,” said Wilczynski. But “if it’s a stock that pays dividends, [you] get dividends every year, and then heirs inherit it.”
Tax planning tip: While this is one situation where doing nothing can pay off, it is still smart to consider what will happen to your appreciated assets as part of your overall estate planning and financial planning. That can help you decide whether you want to use those appreciated assets during your lifetime or pass them on tax-free as a legacy.
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