Big life events often carry complex feelings. But when they also bring along a sudden financial windfall, it can become overwhelming fast. Perhaps you sold a beloved family business or home, or you’ve received an inheritance that changed your financial situation. Working with an expert at this juncture is crucial for identifying opportunities, minimizing taxation, and preserving more of your wealth for retirement, heirs, and the charitable causes close to your heart. Not to mention, working with the right financial advisor can also help restore your peace of mind.
We’ve designed this guide to reduce some of the complexity. We’ll break down the implications for capital gains in retirement, share strategies to help you manage them, and provide the tools you need to avoid costly mistakes.
Understanding Capital Gains in Retirement
There’s a catchy phrase that floats around our office when it comes to capital gains, “Everyone has to pay the government, but we don’t want to give them a tip.” In its simplest form, capital gains are the profits someone makes from selling an asset. Our goal is to help you hold on to as many of them as possible.
Capital gains taxes come from a variety of sources in retirement including inheritance situations, real estate transactions, or business sales as mentioned above, in addition to investment portfolio gains, and even cryptocurrency or collectibles. They’re calculated based on a couple of considerations:
- Time. How long someone held the asset before selling. This falls into two categories: Short-term (from assets held for one year or less, taxed as ordinary income) and long-term (held for more than one year before selling and taxed at lower rates).
- Value. The all-in cost of an asset. Cost basis is the original value of an asset including the purchase price plus any associated costs like commissions, fees, or improvements, as in the case of real estate. A higher cost basis reduces taxable gains when it comes time to sell.
Why Timing Matters
We’ve already established that time plays a significant role in the impact of capital gains. But not just how long you hold onto an asset, also regarding when you choose to sell based on the status of the market or the season of life you’re in. Here are a few things to consider:
- Tax brackets. Where do you fall? Capital gains are taxed at different rates based on income (with long-term taxed at 0%, 15% or 20%). By strategically selling assets during years when you have lower taxable income, you can keep gains within lower percentages too, thereby reducing taxes. It’s also important to be aware that large capital gains can push retirees into higher Medicare IRMAA surcharges and increase taxation on Social Security benefits.
- Market activity. Selling when the market is high may mean you make more, but it could also result in larger capital gains. Many people focus on how market downturns can provide tax-loss harvesting opportunities helping you to offset those gains, but it’s also wise to explore gain harvesting. Rebalancing your portfolio at the right time can help you manage risk and tax impact, as well as provide proper diversification and utilize all available space in your 0% capital gains tax bracket.
- Life events. Large asset sales and inheritance planning often coincide with major life events like retirement or new healthcare needs. Selling before 65 (when you qualify for Social Security or Medicare) and being strategic in how you plan for the future can help you avoid unnecessary tax burdens for you and your heirs.
Common Mistakes to Avoid
It’s important to begin this discussion by saying, the wisest thing you can do is ask an expert for help at the outset. Proactive planning will ensure you’re prepared long before tax season with the right strategies in motion. Plus, everyone feels more confident when they have the support of a knowledgeable, caring team who is committed to their success, and skilled in avoiding the most common pitfalls including:
Overlooking Basis Step-Up Opportunities. For individuals who inherited a property, it’s crucial to consider the step-up in basis for the inherited assets when you decide to sell. Neglecting to do this could result in incorrectly reporting the original purchase price (instead of the fair market value at the time you received the property), leading to unnecessary capital gains taxes.
Misunderstanding Holding Periods. Selling assets too soon can result in short-term capital gains, which are taxed at higher ordinary income rates. It’s better to wait until you qualify for lower long-term capital gains rates.
Neglecting State Tax Implications. Focusing only on federal capital gains taxes and ignoring state-level taxes can lead to unexpected tax liabilities, as some states impose their own capital gains taxes while others offer exemptions or credits.
Strategic Planning for Common Scenarios
Now that we’ve established a few of the most common capital gains scenarios and risks, let’s outline some specific strategies and key considerations for these situations:
The Sale of a Business
Structured sales. This method allows sellers to spread taxable gains over multiple years. This helps reduce the immediate tax burden and potentially keep the seller within a lower tax bracket. By deferring these payments, sellers can more effectively manage cash flow and reduce overall capital gains liability.
Installment sales. Similar to a structured sale, installment sales allow sellers to receive payments over time rather than in a single lump sum. Because capital gains taxes are only due when payments are received, this allows for tax deferral and could also mean lower tax rates if income remains below certain thresholds going forward.
Qualified small business stock (QSBS) exclusions. If the business qualifies under Section 1202 of the Internal Revenue Code, sellers may be eligible for an exclusion of up to 100% capital gains tax on the sale of QSBS held for at least five years. This powerful tax benefit obviously leads to substantial savings, but eligibility requires meeting strict criteria.
Real Estate Transactions
Primary residence exclusions. If a business property also includes a primary residence, sellers may qualify for the Section 121 exclusion, which allows them to exclude up to $250,000 ($500,000 for married couples) of capital gains from taxation if they lived in the home for at least two of the past five years.
1031 exchanges. Also known as a like-kind exchange, a 1031 exchange allows sellers to defer capital gains taxes by reinvesting proceeds from the sale of their business-related real estate into another qualifying property. This strategy preserves capital and provides continued investment growth while deferring taxes indefinitely, as long as reinvestment rules are followed.
Delaware Statutory Trusts (DSTs). A DST is a passive real estate investment vehicle that allows sellers to reinvest proceeds from a real estate sale into institutional-grade properties while qualifying for 1031 exchange benefits. This approach enables tax deferral, diversification, and professional property management without having direct landlord responsibilities.
Qualified Opportunity Zone (QOZ). QOZs are designed to spur economic growth in designated low-income areas while providing investors with significant tax incentives. Investors can defer capital gains taxes by reinvesting gains from the sale into a Qualified Opportunity Fund within 180 days of the transaction. This allows for a partial tax reduction if the investment is held for at least 5 years before December 31, 2026, and a permanent gains exclusion if it’s held for at least 10 years. Any additional gains from the QOF investment itself are completely tax-free when sold.
Investment Portfolio Management
As discussed in the Timing section above, there are primarily three different ways to deal with capital gains related to your portfolio.
Tax-loss harvesting. Investors can sell underperforming assets at a loss to offset capital gains from more profitable investments. These losses can also offset up to $3,000 of ordinary income per year and be carried forward if unused.
Gain-loss offsetting. By strategically selling investments with gains and losses in the same tax year, investors can minimize net taxable gains. Short-term losses are best used to offset short-term gains, which are taxed at higher ordinary income rates.
Strategic rebalancing. Instead of selling assets outright, investors can rebalance portfolios by directing new capital to underweighted asset classes or using tax-advantaged accounts to execute trades without immediate tax consequences.
Inheritance Planning
Step-up in basis. Beneficiaries receive inherited assets at their fair market value at the time of the original owner’s death, eliminating capital gains on any appreciation that occurred during the original owner’s lifetime. This significantly reduces potential tax liability when the asset is later sold.
Trust considerations. Establishing revocable or irrevocable trusts can help manage asset transfers efficiently while potentially reducing estate and capital gains taxes. Certain trusts, like charitable remainder trusts, can also allow for tax-deferred growth and generate income.
Gifting strategies. Transferring assets during one’s lifetime through annual gifting within the IRS gift tax exclusion limit, or using the lifetime estate and gift tax exemption can help reduce the taxable estate while potentially shifting gains to recipients in lower tax brackets.
Digging Deeper: Advanced Tax Minimization Strategies
Many people who desire to practice Biblical stewardship of their finances find the following strategies to be an ideal fit for reducing their tax burden, while also taking care of the charities and loved ones they care about.
Donor-Advised Funds (DAFs) allow individuals to donate appreciated securities or assets, receive an immediate tax deduction, and avoid capital gains taxes on the appreciation while maintaining the ability to distribute funds to charities on their own timetable.
Charitable Remainder Trusts (CRTs) enable donors to transfer assets into an irrevocable trust, receive income from the trust for a set period, and ultimately donate the remaining assets to charity. This structure defers capital gains taxes and provides an immediate charitable deduction.
Direct Gifting of Appreciated Assets. Instead of first selling your asset and donating the money to charity, consider giving them the appreciated assets directly. This approach allows donors to bypass capital gains taxes entirely while also claiming a tax deduction for the asset’s fair market value.
Another way to reduce tax liability is by consulting with an expert to restructure or reconfigure your investments into more tax-smart vehicles or strategies. For instance, IRAs, Health Savings Accounts, and 401(k)s can defer or effectively eliminate capital gains taxes. You may also consider alternative investment options like municipal bonds, or intuitively shift your portfolio to ensure tax-efficient assets are in taxable accounts, while those that are historically less tax efficient are placed into tax-deferred ones.
Creating Your Capital Gains Strategy
As you look at this season of your life and hold the complexity of whatever life transitions you’re facing, we want to help you cut through the haze and get a clear vision for the future. We can help you to feel confident you’ve made the right choices with the assets you’ve been given, and that your plan is God-honoring, strategic, and effective. These are your best next steps:
Assessment. Begin by evaluating your current financial situation including income, investments, and possible capital gains exposure. Think through any future transactions, such as the sale of real estate, stocks, or a business in light of the topics we outlined above. Can you identify areas where potential tax liabilities or savings may be? We can conduct a projection analysis to estimate the impact of future gains and pinpoint your best time to sell.
Implementation. Review your investment portfolio for tax-loss harvesting opportunities, adjusting investment structures, or identifying assets eligible for step-up in basis and roll out the strategic planning strategy that makes sense for you.
Expertise. We’re always here to help. Together we can structure your investments in the most tax-efficient manner and ensure any future sales strategically dovetail into your overall wealth-building goals. At Avena, we always help our clients approach their financial world through the lens of their faith and values, so we’ll make sure it all aligns.
Here to be the Partner you Need
We hope this brief overview has helped you get your bearings. If you’re ready for help, please reach out to us and set up a time to talk.
Remember, you don’t have to struggle with the overwhelm of this season on your own and proactive planning is key. Set up your consultation today and let’s design a plan to help you minimize taxable impact and hold on to more of those gains.