It is often said that there are two things in life that are unavoidable: death and taxes. While taxes are unavoidable for the most part, your financial decisions – specifically the timing of those decisions – can have a great impact on how much you inevitably end up handing over to the government. Before you make any major decisions regarding the selling or even giving away an asset you must first consider the tax consequences.
Capital gains taxes are the best example of timing playing a crucial role in your tax bill. If you buy an asset and sell it 11 months later your tax bill will be greater than if you had waited one additional month. That is because capital gains tax rates are lower than ordinary income tax rates. Any gain on an asset that is held for less than 12 months is treated as ordinary income and taxed at your marginal tax bracket (the highest bracket for your level of income). For most Americans, the capital gains rate is 15%, but for some under a certain income threshold, the rate is actually 0%.
Another great example of timing having an impact on your tax bill is “stepped-up basis”. This has to do with how the process of inheriting an asset impacts capital gains. Your gain is always determined by the difference between what you sold an asset for and what you paid for it. What you paid for it is commonly referred to as your basis. When you inherit an asset your basis in the property is the same as the fair market value on the date the decedent passed. Therefore, if you sell the property you inherited the next day, there is virtually no tax owed because technically there is no gain. If, however, you are gifted the asset while the donor is still alive and sell it, you must use the donor’s basis to compute the gain. The differences here can be significant.
I’m often asked for advice when it comes to minimizing income taxes. If you are an employee who receives a W-2 or a retiree who receives strictly pension and social security, then there is not much you can do. However, self-employed individuals or those who own investment property have many options to deduct expenses therefore reducing their taxable income. Be sure to seek out the advice of a tax professional before making any decisions.