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Capital Gains Tax and Your Estate: What You Need to Know

Confused about the role of capital gains tax in your will? Learn how to use a properly prepared estate plan to avoid and reduce paying capital gains tax.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

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Are you thinking about your Estate Plan, wondering how you can be smart about setting yourself up for the future? Have you wondered how a capital gains tax might affect you and your estate in the long run? 

Ready to learn how to leverage your risk through a properly prepared Estate Plan? Because believe it or not, you actually can do that...

We’re helping you understand everything you need to know about avoiding and/or reducing your capital gains tax rate. Read on, as we’ll look at:

Looking to have a better understanding of the fundamentals of Estate Planning? Check out our resource guide: Estate Planning 101: What is Estate Planning? 

What Is Capital Gains Tax?

Capital gains tax is the amount of taxes you’ll owe on investments when you sell them. The amount of tax is calculated based on the growth you earn. So, if you paid $1,000 for a stock and sold it for $5,000, the difference would be the amount that could be taxable - in this case, taxes would be based on that $4,000 gain.

There are a lot of nuances and regulations surrounding when, if and how much you might owe in capital gains, so let’s look closely at the ins and outs of how you can be smart now, so you can save money in the future.

Commonly Asked Questions About Capital Gains Tax and Your Estate

As that old saying goes, knowledge is power. When you’re armed with as much information as possible, you can better set yourself, your estate and your assets or investments up to weather any capital gains storm. Below, we’ll discuss the most commonly asked questions investors have when they really start looking at their Estate Plan as a savings tool, so they aren’t one day facing more loss than necessary. 

How Can I Avoid Capital Gains Tax With My Estate Planning?

This may be the single most important question you’ll want to delve into when you begin to position your Estate Plan so it can protect your assets. First, know this: it is 100% possible to avoid or substantially reduce some potential capital gains when you use your Estate Plan as a smart, effective tool. 

Ready to look at some proven strategies to do just that? 

Factor In Your Biggest Assets - Namely, Your Home

Many people just assume their home will be subject to capital gains tax once they sell it. If you purchased in a buyers’ market (meaning you got a good deal on a house), or lived there long enough to have significant equity, it’s likely you’ll sell at a profit. 

But here’s some really good news - most often, your physical home (the place you actually live) is exempt from capital gains taxes. There are a few stipulations you need to know about if you’re hoping to reap the rewards of this exemption. To avoid capital gains on real estate, the following must be true:

  • Property was your primary residence (known as “owner-occupied”)

  • You owned it for at least two of the last five years

  • You didn’t already exclude gains from another residential sale in the same two-year period

Consider Setting up a Trust

Setting up the proper type of Trust can be a smart move if you’re hoping to avoid capital gains. You’ll notice we said “the proper type” there...and that’s important. If your goal is to eventually avoid unrealized gains - meaning you have assets or property worth more now what you paid for them - you need to be careful about the type of Trust you set up. 

Unfortunately, a Revocable Living Trust (a common Trust type) may not be the path you want to take. Rather, an Upstream Basis Trust (USB Trust) can be used to strategically navigate the capital gains game. It can not only help you potentially eliminate capital gains, but it may also allow you to reduce estate tax while offering asset protection.

For estates with assets that have tremendous appreciation, a Joint-Exempt Step-Up Trust (JEST) or an Estate Trust could allow surviving spouses to sell assets while avoiding capital gains.

Who Pays Capital Gains Tax in a Trust?

Income realized on assets inside the Trust is taxed, and if it’s not distributed to beneficiaries, it’s paid for by the Trust every year. Usually, beneficiaries who receive distributions on the Trust’s income will be taxed individually. 

Trusts are taxable entities, however preferential capital gains rates can be used. Trusts can also offset capital gains and a set amount of ordinary capital losses, while carrying excess loss into future tax years. Through capital losses, Trusts can offset capital gains. And, as noted, they can carry over excess losses that go beyond the cap to future tax years. Note these losses cannot be passed through to beneficiaries though. 

What’s the Difference Between Long-Term and Short-Term Capital Gains?

Long-term and short-term capital gains are different. Long-term gains are taxed at either 0 percent, 15 percent or 20 percent, and the rate is dependent on your taxable income. You could owe long-term capital gains after selling assets that you owned longer than one year. 

Short-term gains, by contrast, result from assets you sell after owning them for one year or less. Rates on short-term capital gains are the same as your income tax bracket. 

Can a Trust Avoid Capital Gains Tax?  

In short, yes, a Trust can avoid some capital gains tax. Trusts qualify for a capital gains tax discount, but there are some rules around this benefit. Namely, the Trust needs to have held an asset for at least one year before selling it to take advantage of the CGT discount.

Being smart with your money now, setting up a plan that works for you, can literally pay off in the long run. If you’re ready to get started on an Estate Plan you can count on, now is the perfect time to make sure everything - from your beneficiaries to your capital gains tax plan - is set up in a way you know will benefit your legacy for generations. 

Is there a question here we didn’t answer? Reach out to us today or Chat with a live member support representative!

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