Lighten up: lessen your capital gains tax burden with these strategies

Entrepreneur, August, 1997 by Joan Szabo

Planning ahead now may be especially wise for investors who have reaped healthy returns in the stock market during the past two years and are mulling over the possibility of selling some of their winners in 1997. It's important to factor these gains into your overall tax liability and plan accordingly so you don't get socked with an unexpectedly large tax bill when it comes time to file your return.

The current top capital gains rate is 28 percent for individuals. The budget deal agreed to by President Clinton and congressional Republicans calls for a reduction in capital gains taxes, but the details on how much the tax will be trimmed is still in congressional tax-writing committees.

SAVINGS PLAN

Even without a congressional cut in the capital gains rate, using sound tax strategies can save you a bundle, says Ralph J. Anderson Jr., a partner in charge of taxation and financial services for New York City accounting firm M.R. Weiser & Co. LLP.

To help ease your capital gains tax burden, tax experts offer the following strategies:

1. Sell investment losers. If you're ready to cash in on some of your winning investments, take a look at your whole portfolio, advises Anderson. Sell any losers to help offset the profits from your winners. The tax laws allow you to write off any amount of gains as long as you have corresponding losses. If your losses are more than your capital gains, you can write off up to $3,000 against ordinary income each year. If that doesn't take care of all your losses, you can carry the remaining amount into future tax years and continue to offset gains, explains Anderson.

2. Sell your business or property in installments. This allows you to divide up the payments over time, says Pamela Pecarich, a director in accounting firm Coopers & Lybrand LLP's San Francisco office. "With an installment agreement," she says, "you can take some of the money later in the hopes that what you are selling will qualify for a reduced capital gains rate." This strategy assumes, of course, that Congress will lower the capital gains tax rate.

3. Make a trade on real estate. If you own property that has appreciated in value, it's possible to avoid capital gains taxes by using what's called a "like kind exchange," says Mark Cohen, a CPA with New York City accounting firm Newman & Cohen CPA, PC. This strategy allows the owner to swap one property for another of at least equal value without paying a capital gains tax. The caveat, however, is the exchanged property must be held for investment or used in the course of a trade or business. Trying to exchange personal property or a family home won't fly.

4. Look for losses from Section 1244 stock to offset gains. If you are a shareholder in a qualifying small business that goes bust, you may be able to claim a loss on the portion of stock you hold. To qualify, you must have purchased the stock when the company began. In addition, the total cash or property the company received for stock at the time it was launched can't exceed $1 million. Another requirement is that more than 50 percent of the company's gross revenues must have come from its sales, not passive income such as rents, royalties, dividends, interest or annuities.

Section 1244 is especially appealing because you are not limited to writing off the loss against the gains of other investments. Therefore, it's possible for you to write off up to $50,000 against your individual regular income, or $100,000 for a married couple filing jointly. "It's more attractive than taking regular stock losses because you are not limited to just $3,000 in any given tax year," says Cohen.

5. Donate appreciated stock to charity. You can make a contribution of stock to your favorite charity, says Anderson. Not only is the gift tax deductible, but you avoid paying the capital gains tax. This makes more sense than selling the stock, paying the capital gains, and giving what's left over to the charity. As of May 31, the deduction is limited to the cost of what you paid for the stock, not its fair market value.

6. Consider setting up a Charitable Remainder Trust (CRT). Not only will a CRT help the charity of your choice, but it also eliminates the capital gains taxes on your assets that have appreciated in value. Here's how it works: You transfer the desired assets to a trust, which is held in the designated charity's name. The trust sells the property and reinvests the proceeds, allowing you to receive a steady stream of income from the fund for a specified number of years or during your lifetime and your spouse's.

You pay regular income taxes on the money you receive from the trust. When the term of the trust ends, the charity becomes the owner of what remains in the CRT. Unlike taxpayers, the trust is tax exempt, so it's not required to pay any income or capital gains taxes. There are special rules that must be followed in setting up a CRT, so be sure to check with your accountant on the details.

When considering selling investments, your primary concern should be whether the sale makes financial sense, says Anderson. Don't let the tax tail wag the dog when deciding whether to sell your holdings. "If you believe it's time to sell your business and you have a qualified buyer, don't be put off because of capital gains taxes," Anderson adds. If you wait until tax rates are lower, you may not be able to sell at all or you'll have to settle for a lower price. On the other hand, if you believe the potential is there for further growth, you'll want to hold on to it until the time is right to sell.