Considering the tax implications of key financial moves could save you money. Here’s what you need to know.
Buying or Selling Your Home
You may be eligible for a capital gains tax exclusion on the first $250,000 of profit — $500,000 if you’re married and file jointly — when selling your primary residence.
You, and your spouse if you’re married, must have lived in the house for at least two of the past five years before the date of the sale. With the maximum capital gains tax rate generally at 20%, this exclusion could save you up to $100,000 in federal income tax. The exclusion can’t be used if you excluded the gain from the sale of another home within the prior two years from the date of the sale.
Staying until the two-year threshold has been met, as the capital gains exclusion applies only to a home used as your primary residence for at least two years.
When calculating the amount of federal income tax owed on the sale, you can add the cost of certain qualifying home improvements you make before you sell to the cost basis of the home. The higher the basis of the home, the smaller your capital gain, which should result in a lower federal income tax liability.
Healthcare Costs
See if your employer offers a high-deductible health plan that enables you to make contributions to a qualifying health savings account (HSA). If you meet the eligibility requirements for an HSA, your contributions are tax-deductible or may be made by pre-tax salary deductions if allowed by your employer. Earnings and withdrawals for qualified medical expenses are federal income tax-free.
If your HSA allows you to invest the money you contribute, its potential growth could help you pay for healthcare costs as you age and even cover the cost of Medicare premiums.
Contributing money to an employer-sponsored flexible spending account (FSA) for healthcare expenses is another way to lower your federally taxable income. Participating in certain types of FSAs may have an impact on your eligibility for HSA contributions, so check with your Human Resources department to check your eligibility.
Selling Stocks & Bonds
Bond interest and dividends from real estate investment trusts (REITs) are generally taxed as ordinary income for federal income tax purposes, at rates as high as 37%. Qualified dividends and gains from the sale of investments held for more than a year are eligible for long-term capital gains rates, which are currently capped at 20%. In either case, an additional 3.8% net investment income tax may apply for taxpayers with incomes above a certain threshold.
Generally, consider holding non-income-producing investments, such as growth stocks, in your taxable accounts and keeping investments that generate income, like corporate bonds, in tax-deferred accounts.
It’s possible to offset capital gains by selling investments that have dropped in value. You can generally deduct up to $3,000 (or $1,500 if married and filing separately) of capital losses more than capital gains per year from your ordinary income. Any unused capital losses may be carried forward to the next taxable year.
Investing for Retirement
Traditional 401(k) contributions are made on a pre-tax basis, giving you immediate savings by reducing your federal taxable income. In addition, investment income in your traditional 401(k) account is not subject to federal income taxes until the money is taken out at retirement. Roth 401(k) contributions are made with after-tax income, but then qualified withdrawals starting at age 59½ are potentially federal income tax-free.
Splitting your contributions, putting in enough as traditional 401(k) contributions to limit your taxable income and keep from rising into a higher tax bracket, then putting the rest in as Roth 401(k) contributions.
Be sure to contribute enough to your 401(k) to earn the maximum matching contribution from your employer. Until recently, companies could allocate matching contributions only to a pre-tax account in your 401(k) plan, meaning any match of the employee’s Roth contributions would be made on a pre-tax basis. Since the enactment of the SECURE 2.0 Act of 2022, employers can now offer the option to match contributions on a Roth basis as well; it would then be up to the employee to elect the option.
This is just a sampling of the kinds of situations where you might benefit from being more tax aware. Tax laws change frequently, and anticipating future shifts in tax rates and rules could help to influence the financial decisions you make today.
If you would like to set up a tax strategy for your wealth management decisions, please call us at (631) 585-9698.
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