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capital gains taxes

Q&A: Advisor may have overlooked tax bill alternatives

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Dear Readers: The following comment was prompted by my response to the letter from a couple in their 70s asking if they had made a mistake moving their $2-million portfolio, including $340,000 in a taxable account, to a new advisor. The advisor recommended investment sales that resulted in a $50,000 capital gain tax bill, and their accountant disapproved. I wrote that the tax pro might not be in the best position to judge whether the sales were necessary, since accountants are typically focused on reducing tax bills but sometimes diversification is necessary to avoid even bigger financial consequences down the road. Here’s another perspective.

Dear Liz: The comment that the accountant is not in the best position to evaluate is correct, as the accountant is only looking at the taxes. However, as a retired portfolio manager and chartered financial analyst, I really doubt that it was appropriate for the investment manager to take this large of an amount of capital gains. It would only make sense if this taxable portfolio had nothing but speculative issues in it, which I would find doubtful for a couple in their late 70s. If the taxable account was too high in equities or poorly diversified by industry weightings, adjustments can be made in the larger retirement account to bring the combined account into better balance. It may have been appropriate to take some gains, but they can certainly be spread out over several years, as taking them all at once likely puts the couple in a higher tax bracket.

Answer: You’re making a good point that the couple had other options besides “ripping off the Band-Aid” and incurring one big tax bill rather than taking the gains more gradually. Their new advisor, as a fiduciary, should have discussed the options with them and helped them understand the impacts, including the expected tax bills and potential impact on Medicare premiums. If those discussions didn’t happen, that’s all the more reason to seek out a second opinion from another fee-only financial planner.

Q&A: Was it a mistake to incur a large tax bill?

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Dear Liz: We are a retired couple in our late 70s. I worked as a carpenter and my wife worked as a nurse. We saved and invested for the long haul with a well-known discount brokerage. Last summer, we were wooed by another financial services firm with a “much better idea.” Our combined portfolio at the time was $1,985,000. We transferred our holdings, including $340,000 in a taxable account.

The transfer triggered a capital gain of $184,000 as the new company sold the old funds and reinvested the money according to their plan. This caused us to owe about $50,000 in income tax this year rather than breaking even or receiving a refund. Our holdings have grown to $2,013,119 after our 2026 required minimum distributions have been taken. Was this a good move given the large tax bill? Our tax accountant is very critical of the sale of these funds.

Answer: Your accountant may not be in the best position to evaluate whether this was the right move for you.

Tax pros are typically focused on saving their clients money. That often means delaying or avoiding moves that could trigger capital gains taxes. Sometimes, though, such moves are necessary to avoid even bigger financial costs down the road.

The stock market gains of recent years mean that many people have portfolios that are now too heavily invested in stocks, particularly if they haven’t been regularly rebalancing their investment mix. These stock-heavy portfolios can leave people painfully exposed to downturns.

I redacted the names of the firms, but both companies you mentioned in your letter have good reputations. Your previous brokerage caters to do-it-yourself investors who want to minimize fees, while your new one provides fiduciary advice, meaning that they’re required to put their clients’ best interests first. It’s easy to imagine you investing for decades on your own without an advisor’s help or appropriate rebalancing; the new firm sees how risky your portfolio has become and diversifies it after careful discussions with you about your age, situation and goals.

Imagination is not reality, though, and the most concerning part of your letter is your vagueness about why you moved your money. You should be able to articulate in basic terms why this transfer made sense. “Our portfolio was too risky” or “I had too many of the same type of stocks” or “I realized I needed help” are all appropriate reasons. “A much better idea” is not.

The right move now might be to get a second opinion from a fee-only financial planner. Someone who charges by the hour could review your portfolio and let you know if you’re now on the right track. You can get referrals from the Garrett Planning Network at https://garrettplanningnetwork.com/.

Q&A: How to finance a remodeling project

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Dear Liz: I am doing a small remodeling job to my home that will cost $80,000. I have enough in my investments to withdraw the $80,000. Is it better, tax wise, to get a home equity loan to pay for it?

Answer: Like so many tax questions, the answer depends on your circumstances. How your investments would be taxed depends in part on what account they’re in. Withdrawals from most retirement accounts are taxed as income, and can incur penalties if you take the money out too early.

Withdrawals from regular brokerage accounts also can be taxed as income if you’ve held the investments less than one year. If the investments have been held for more than one year, you can qualify for more beneficial capital gains tax rates. The amount of tax you would pay depends on how much the investments appreciated in value since you bought them as well as your income tax bracket. Most people pay a federal capital gains rate of 15%, although lower income taxpayers can qualify for a 0% rate while higher earners pay 20%.

You may have the opportunity to engage in what’s known as “tax loss harvesting.” That means selling investments that have lost value since you bought them, and using that loss to offset the gains on other investments you’ve sold.

Interest on home equity borrowing, meanwhile, may be deductible if the proceeds are used to improve your home and the combined total of your mortgage debt doesn’t exceed $750,000 for a married couple filing jointly or $375,000 for singles.

To deduct the interest, though, you must itemize your deductions. The vast majority of taxpayers now take the standard deduction of $31,500 for married couples or $15,750 for singles. People 65 and older can take an additional $1,600 per qualifying spouse or $2,000 if single. In addition, people 65 and over can take an additional $6,000 bonus deduction if their income is under certain limits. The bonus begins to phase out for single filers with modified adjusted gross income over $75,000, and for joint filers over $150,000.

That’s the long answer. The shorter answer is that the taxes you’ll pay cashing in your investments are likely to be less, and perhaps significantly less, than the interest you’d pay on the loan. But you’ll need to do your own math, or ask a tax pro for help.

Q&A: Sale of last home can trigger capital gains taxes

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Dear Liz: I am 74 and my husband is 68. We have decided to sell our last home and rent. Do we have to pay taxes, specifically capital gains, on the sale of our last home or are we able to keep the sale proceeds in full?

Answer: Any home sale is potentially subject to capital gains taxes. Your gain is determined by subtracting your tax basis — the price you paid for the home, plus any qualifying improvements — from the net sales proceeds. If you owned and lived in the home as your primary residence for at least two of the previous five years, you can exclude up to $250,000 (or $500,000 if married filing jointly) of home sale profits. You would owe taxes on the capital gains that exceed those limits.

A large-enough capital gain could affect how much you pay for Medicare. The “income-related adjustment amount,” or IRMAA, is based on your income two years prior, so a big gain in 2025 could increase your premiums in 2027.

You’d be smart to talk to a tax pro before you sell so you understand the ramifications.

Q&A: When receipts of home renovations are lost, is the tax break gone too?

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Dear Liz: I have sold my family home recently after almost 50 years. I had done lots of improvements throughout those years. Due to a fire 15 years ago, all the documentation for these improvements has been destroyed. How do I document the improvements for the capital gains tax calculation?

Answer: As you probably know, you can exclude $250,000 of capital gains from the sale of a principal residence as long as you own and live in the home at least two of the previous five years. The exclusion is $500,000 for a couple.

Once upon a time, that meant few homeowners had to worry about capital gains taxes on the sale of their home. But the exclusion amounts haven’t changed since they were created in 1997, even as home values have soared. Qualifying home improvements can be used to increase your tax basis in the home and thus decrease your tax bill, but the IRS probably will demand proof of those changes should you be audited.

You could ask any contractors you used who are still in business if they will provide written verification of the work they performed, suggests Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. You also could check your home’s history with your property tax assessor to see if its assessment was adjusted to reflect any of the improvements.

At a minimum, prepare a list from memory of the improvements you made, including the year and the approximate cost. If you don’t have pictures of the house reflecting the changes, perhaps friends and relatives might. This won’t be the best evidence, Luscombe concedes, but it might get the IRS to accept at least some increase in your tax basis.

If you’re a widow or widower, there’s another tax break you should know about. At least part of your home would have gotten a step-up in tax basis if you were married and your co-owner spouse died. In most states, the half owned by the deceased spouse would get a new tax basis reflecting the home’s current market value. In community property states such as California, both halves of the house get this step-up. A tax pro can provide more details.

Other homeowners should take note of the importance of keeping good digital records. While documents may not be lost in a fire, they may be misplaced, accidentally discarded or (in the case of receipts) so faded they’re illegible. To make sure documents are available when you need them, consider scanning or taking photographs of your records and keeping multiple copies, such as one set in your computer and another in a secure cloud account.

Q&A: Clearing up some confusion over those proprietary funds

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Dear Liz: Your recent column about proprietary funds confused me. You mentioned that selling these funds can trigger capital gains tax. Is it not true we can move investments directly from one money manager to another and not take a capital gain as long as the funds remain invested?

Answer: If you can move a fund from one investment company to another, then it likely is not a proprietary fund. For example, Schwab, Fidelity, Vanguard and many other firms create funds that bear their names, but these investments can be bought and sold at other brokerages.

Proprietary funds, by contrast, typically lock customers into investments that can’t be transferred to another firm. To get your money out, you have to sell the fund, which can trigger a tax bill. This is a significant downside and one investors should understand before committing their money to this type of fund.