Recent discussions around proposed changes to capital gains taxes have brought this topic sharply into the spotlight, both nationally and at state level.
The proposal initially introduced by President Biden aims to impose a 25% minimum tax on unrealized capital gains for Americans with a net worth of $100 million or more.
While the plan would impact only a small fraction of the country’s wealthiest, it has sparked widespread debate over how capital gains should be taxed, including here in Texas.
With these potential shifts on the horizon, Texas residents, investors, and businesses are once again exploring the implications of capital gains tax on personal wealth and the economic growth of the Lone Star State.
We bring you an understanding of how capital gains taxes affect Texas residents and what you can do to secure your wealth at a time when economic growth is at the forefront of everyone’s minds.
Do you pay capital gains taxes in Texas?
It boils down to this: If you’re an individual taxpayer, business owner, or a high income earner in Texas, you won’t pay state capital gains tax, but you will need to comply with federal capital gains taxes.
Federal capital gains tax: What is it?
A capital gain occurs when you sell an asset for more than what you paid for it. These assets can be anything from stocks, and property to private investments. The IRS taxes these gains under two categories:
Short term capital gains
Short term capital gains apply if you hold an asset for one year or less before selling it. Short term gains are taxed as ordinary income, which is subject to the same tax rates as your regular earnings, ranging from 10% - 37%, depending on your tax bracket.
Long term capital gains
Long term capital gains apply when you hold an asset for more than a year before selling. Based on your taxable income, these capital gains are taxed at a lower preferential rate: 0%, 15%, or 20%. Here’s a breakdown according to tax brackets:
Percentage | Taxable income |
0% | If your taxable income is up to $44,265 for single filers or $89,250 for married couples filing jointly |
15% | If your taxable income is up to $492,300 for single filers or $553,850 for married couples filing jointly |
20% | If your taxable income exceeds $492,300 for single filers or $553,850 for married couples filing jointly |
High-income earners: The net investment income tax (NIIT)
If you’re a high-income earner, besides the ordinary capital gains tax liability, you may be subject to an additional tax known as the Net Investment Income Tax (NIIT).
This tax adds an extra 3.8% on top of your regular capital gains tax if your modified adjusted gross income (MAGI) exceeds the following thresholds:
$200,00 for single filers
$250,000 for married couples filing jointly
The NIIT applies to investment income, including interest, dividends, and capital gains. So, if you fall into this category, your effective capital gains tax rate could be 18.8% or 23.8% for long-term gains, depending on your income level.
What can be done to avoid paying high capital gains tax?
Several key sections of the Internal Revenue Code (IRC) govern how capital gains are taxed. Understanding these can better help you manage your tax liability, whether you’re selling stocks, real estate, or business assets.
IRC Section 121: Primary residence exclusion
This is a very attractive exclusion for high-income earners because this rule allows you to exclude $250,000 in capital gains ($500,000 for married couples) from the sale of your primary home. There are a number of stipulations that you must meet to qualify for this exclusion, namely:
You must have owned the home for at least two out of five years
You must have lived in the home as your primary residence for at least two out of five years
You can’t have claimed this exclusion on another property sale in the last two years.
IRC Section 1031: Like-kind exchanges for real estate investors
If you’re a real estate investor, you can take advantage of the 1301 exchange, which allows you to defer capital gains taxes when selling a property, provided you reinvest the proceeds into a “like-kind” property.
The new property must be of equal or greater value, you must identify the replacement property within 45 days and complete the purchase within 180 days, and it must be for similar use. Note that you will eventually have to pay capital gains tax on the sale of the second property unless another 1031 exchange is used. “Like-kind” is a powerful way to avoid capital gains tax until you eventually sell your property without reinvestment.
IRC Section 1400Z-2: Opportunity zone for deferral and exemption
Another way to defer or even eliminate capital gains taxes is by investing in Qualified Opportunity Zones (QOZs). These zones are established to spur economic development in underserved areas.
You can defer net capital gains by investing them in a QOF (Qualified Opportunity Fund) within 180 days of realizing a gain. If you hold this QOF for at least 10 years, you won’t owe any capital gains on the appreciation of the new investment.
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Hall Accounting Company has been working with individual taxpayers and businesses in Texas to reduce capital gains taxes and secure investment into local initiatives that grow our economy. Speak to our senior tax associates today about ways you can reduce or defer capital gains taxation.
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Now that we’ve discussed some basic strategies you can follow to deal with your capital gains tax obligations, let’s discuss one specific strategy more in depth. This strategy is called tax-loss harvesting and is applicable to realized gains from the sale of investments. After this, we’ll circle back around to explain why the latest news about unrealized capital gains has the business world up in arms.
Tax-Loss Harvesting
Tax-loss harvesting is the timely selling of securities at a loss to offset the amount of capital gains tax owed from selling profitable assets. Losses can offset gains on a dollar-to-dollar basis, and if your losses exceed your gains, you can use up to $3,000 of excess losses to offset ordinary income.
Tax-loss harvesting is completely legal and encouraged by the U.S. tax system as long as you follow the rules laid out in the Internal Revenue Code (IRC).
The IRS provides a framework to ensure the strategy is applied fairly and doesn’t result in tax avoidance. Investors can only claim losses on sales of investments where they incur real losses, and they must adhere to the wash sale rule (discussed below) to prevent abuses.
Wash sale rule
The wash sale rule prevents investors from claiming a tax loss if they repurchase the same security (or a substantially identical one) within 30 days before or after the sale that generated the loss. If the wash sale rule is triggered, the loss is disallowed for tax purposes, but the disallowed loss is added to the cost basis of the newly purchased security. This means you can eventually claim the loss when you sell the repurchased asset.
Apply tax-loss harvesting legitimately
To ensure the legitimacy of tax-loss harvesting, investors should adhere to several important principles:
Document everything - Proper record-keeping is essential for proving the timing and legitimacy of your transactions.
Avoid wash sales - Time the sale and repurchase of investments carefully. The 30-day window (before and after the sale) must be observed to ensure that losses are deductible.
Understand the type of assets involved - Different rules apply depending on whether you are selling stocks, mutual funds, real estate, or other capital assets.
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Due to the complexity of the tax code and the potential for unintended consequences (like triggering a wash sale or making incorrect cost basis adjustments), it is highly recommended to work with a CPA when implementing tax-loss harvesting strategies.
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For businesses and high-net worth individuals, tax-loss harvesting can be particularly advantageous. For owners of S corporations or LLCs, capital losses flow through to your personal tax returns. Tax-loss harvesting can help offset personal capital gains or other taxable income.
Corporations are subject to special rules regarding capital losses. They cannot deduct capital losses against ordinary income but can carry losses forward or backward to offset capital gains in other years.
Businesses with investment portfolios (such as hedge funds or private equity firms) often use tax-loss harvesting as part of their tax reduction strategy.
Why is the possibility of capital gains tax on unrealized gains causing a stir?
At the start of our discussion, we acknowledged that the latest news about the possibility of capital gains tax on unrealized gains had stirred up a hornet's nest and made people nervous, not just those earning over $100 million. The reality that this could be in the pipeline come the end of 2024 brought out interesting concerns in the media.
According to Patrick Bet David, CEO and founder of Valuetainment, the potential effect of this policy being enacted could result in not only the wealthy parting with their money but potentially the middle-class workers losing their jobs, as wealthy business owners scramble to recoup their losses.
Bet David poses that the same question applies to the wealthy and the middle class, who have their net incomes squeezed year on year.
Would you rather have trillions of dollars go to the government in taxes, or would you rather have that money in the hands of local entrepreneurs, job creators, and business people who are committed to pushing the money back into the economy?
It’s an interesting question, and the fact that people are having conversations about capital gains taxes off the back of this news tells us all what the people want - they want to reinvest in their communities.
Taxfoundation.org is the go-to website for up-to-date information and analysis on all things tax. They released a report on the proposed tax plan, showing that the government plans to make $1.2 trillion over 10 years from individual taxpayers alone. One of the changes will affect the ‘like-kind’ initiative we mentioned earlier, limiting the gain to $500K and, of course, the 25% tax on unrealized gains. This alone will put $516 billion into government coffers.
As the current government puts plans in place to raise a total of $ 4.1 trillion over the next 10 years from American citizens and businesses, it is no wonder that taxpayers and large corporations are resurrecting conversations on federal taxes and capital gains tax rates.
These are the kinds of conversations residents of the U.S. and, more specifically, the state of Texas should be having if we’re going to build a better economy for the future.
Final Thoughts from Hall Accounting Company
As the discussion around capital gains tax evolves, understanding its implications is more critical than ever—especially for those in Texas. While the recent proposals may directly impact only a small fraction of high-net-worth individuals, the ripple effects could reach across investment strategies, business decisions, and community growth.
By staying informed and exploring strategies like tax-loss harvesting, Texans can navigate these changes proactively. At Hall Accounting Company, we’re here to help you secure your financial future, ensuring that your wealth continues to contribute to the prosperity of the Lone Star State.