Are You Leaving Potential Tax Savings on the Table?
Could a strategic move today save you significant money on your investment gains tomorrow? Understanding the current landscape of capital gains taxes is the first step in answering that crucial question.
Capital gains are the profit from selling an asset, such as stocks, bonds, or real estate, for a higher price than what you bought it at. These gains are taxable. The amount of tax owed depends on how long the asset was held before being sold. Short-term capital gains, from assets held for one year or less, are taxed at the individual’s ordinary income tax rate, which can range from 10% to 37% in 20251. Long-term capital gains, from assets held for over a year, are taxed at more favorable rates of 0%, 15%, or 20%, depending on the taxpayer’s taxable income2.
Currently, in 2025, the long-term capital gains tax rates remain relatively low for many investors. For example, single filers with taxable income up to $48,350 and married couples filing jointly with taxable income up to $96,700 may owe 0% in long-term capital gains tax. While these rates have seen slight adjustments due to inflation, the overall structure provides a window of opportunity for strategic tax planning.
Given the current landscape and historical trends, there is a possibility of future capital gains tax increases. Capital gains tax rates have fluctuated over time, and political discussions often include proposals to raise rates, particularly for higher-income earners.
In this context, realizing a substantial capital gain now, while tax rates are comparatively low, can be a strategic move to protect against potential future tax increases. By taking gains in the current environment, investors can lock in today’s lower tax burden on their investment profits. This article will delve into the benefits and drawbacks of realizing capital gains in the current low tax environment, explore strategies for reinvesting proceeds, and highlight crucial considerations for making informed financial decisions.
Understanding the Current Tax Landscape
Currently, the tax rate for long-term capital gains in the United States operates under a tiered system based on an individual’s taxable income. For most taxpayers, the long-term capital gains tax rates are either 0%, 15%, or 20%. These thresholds are tied to the ordinary income tax brackets, meaning that those in lower income brackets may face no capital gains tax, while higher earners will be subject to the 15% or 20% rates. It’s important to note that short-term capital gains (from assets held for a year or less) are generally taxed at the same rates as ordinary income, which can be significantly higher.
Capital gains tax rates have fluctuated over time. Over the past several decades, the top capital gains tax rate has seen considerable variation, reaching as high as 39% in the late 1970s. Since then, it has generally trended downwards, punctuated by periods of increase and decrease3. This historical volatility underscores a key point: tax policies are not static and may change over time.
From a political standpoint, there have been discussions and proposals from various policymakers to increase taxes on higher-income individuals and investment gains as a way to address income inequality and fund government initiatives. A large government deficit could also add pressure for higher taxes across the board, including capital gains. While the timing and extent of any potential tax increases are uncertain, the current environment of significant national debt and evolving political priorities makes it a distinct possibility that investors should consider in their long-term financial planning.
Benefits of Realizing a Capital Gain Now
One of the most compelling reasons to consider realizing capital gains in the current tax environment is the opportunity to lock in today’s relatively lower tax rates. By selling appreciated assets now, you can protect yourself against the potential for future tax hikes. Realizing gains now allows you to secure a lower tax burden on your investment profits compared to what you might owe if you were to sell those same assets down the road in a higher tax environment. This difference can translate into a significant amount of money saved over the long term.
Realizing capital gains now also opens strategic possibilities for reinvesting the money. One approach is to shift these funds into tax-advantaged accounts such as traditional IRAs, Roth IRAs, and 401(k)s. While these accounts offer significant tax benefits on future growth, it’s crucial to understand their limitations. There are annual contribution limits to these accounts, which may not accommodate a large influx of capital from realized gains all at once. Additionally, there may be income restrictions that prevent higher-income individuals from contributing directly to Roth IRAs. Reinvesting in these accounts means the funds will be subject to the specific rules and regulations governing withdrawals in retirement, which may not align with all investors’ liquidity needs or time horizons. Finally, it’s important to remember that moving assets into a tax-advantaged account is considered a contribution, not a way to avoid the initial capital gains tax liability from the sale of the original asset. You will still owe taxes on the realized gain in the year the sale occurs.
Another avenue for reinvestment involves exploring tax-free investments, such as specially designed life insurance policies with a cash value component. While not a direct substitute for traditional investments, the cash value in these policies can grow tax-deferred, and under certain conditions, can be accessed tax-free through loans. This can provide a unique way to grow and potentially access funds without incurring further tax liabilities on the gains, and reinvest a large realized gain without a contribution limit.
Finally, realizing capital gains can provide an opportunity to rebalance your overall portfolio. Over time, your initial asset allocation may drift due to varying market performance. Selling appreciated assets that have become a larger portion of your portfolio than intended allows you to take profits and reinvest those funds into other asset classes that may be underrepresented or better aligned with your current financial goals and risk tolerance. This disciplined approach to portfolio management can help you maintain a well-diversified portfolio that is better positioned to meet your long-term objectives.
Drawbacks to Consider Before Selling
While the idea of paying less tax now might sound good, there are a few important things to keep in mind before you decide to realize a large investment gain. First, remember that selling now means you’ll owe taxes on the gain this year. If you have a large gain, this could mean a significant tax bill that you need to pay soon. This could restrict your cash flow or require you to sell other investments to cover it.
Another consideration is market volatility. The value of your investments can go up and down. If you sell now because you’re worried about future taxes, you might end up selling when your investments are temporarily lower in value. You could miss out if the market goes back up shortly after you sell. It’s always a good idea to consult a tax professional before making a decision. They can help you understand how selling now would affect your situation. One more thing to consider is what happens to your investments later. If you plan to leave these investments to your children or other loved ones, they usually get a step up on the value for tax purposes when they inherit them. This means they might not have to pay much tax if they sell them later. If you sell now, that tax benefit for your family could disappear.
Does Today’s Opportunity Make Sense For You?
While the future of capital gains taxes is uncertain, inaction could be costly. Exploring the benefits of the current low tax environment is a proactive step every investor should consider. Realizing substantial investment gains now can offer the benefit of locking in today’s lower tax rates, shielding against the possibility of future tax increases and securing a lower tax burden on your profits. In addition to that, it can open doors to reinvesting proceeds into tax-advantaged accounts or provide an opportunity to rebalance your portfolio to better align with your long-term goals.
However, this decision is not without its drawbacks. Investors must weigh the immediate tax implications of realizing a gain, the potential risks associated with market volatility, and the possibility of foregoing the step-up in basis for estate planning purposes. Ultimately, the best course of action depends highly on individual circumstances, including your current income level, investment horizon, risk tolerance, and estate planning needs. Therefore, it is crucial to consult with a qualified financial professional who can provide personalized guidance based on your unique situation.
While the future of capital gains tax rates remains uncertain, taking proactive steps to understand the current landscape and its potential implications is essential. By carefully evaluating your options and seeking professional advice, you can make informed decisions today to potentially safeguard your wealth against future tax headwinds.
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Written by McAdam Financial as of 6/18/24. This article is provided by McAdam LLC (“McAdam” or the “Firm”) for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. No portion of this article is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax, or legal advice. Certain information contained in this report is derived from sources that McAdam believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
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1 https://www.irs.gov/filing/federal-income-tax-rates-and-brackets
2 https://www.irs.gov/taxtopics/tc409
3 https://taxpolicycenter.org/statistics/historical-capital-gains-and-taxes
Artificial intelligence was used to create this content. The information and opinions contained herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by our firm.