Hindsight is something that we’ve all faced at some time or another in our lives. “If I only… fill in the blank… that parking ticket, the bad haircut, the morning after the long night out with friends. We’ve all experienced the value of hindsight in one way or another. But fewer events provoke more dread than getting a “taxes due” notice from the IRS. And it can happen to even the most experienced and sophisticated of taxpayers—including those with competent, professional tax advisors.
Let’s take a look at a few circumstances that can create unanticipated tax headaches that would have benefited from the value of hindsight. After all, the more you can anticipate and plan ahead, the fewer unwelcome surprise notices you’re likely to receive.
1. Unwinding a concentrated investment position.
Let’s say you inherited a large block of highly appreciated stock from a parent’s company stock-purchase plan. You had a good, diversified investment plan in place and now you’re unsure how this change will affect that. Your diversification strategy dictates that you shouldn’t maintain such significant exposure to a single asset, so you liquidate the position and re-invest in diversified holdings.
But wait… Did you discuss the capital-gains implications of the sale with your tax advisor? The time to talk about this is before it happens so that you can ask question and get informed about the impact. Some question you can ask: Do you know if you received a stepped-up cost basis? If so, what was it? Did the stock appreciate above that basis between the time you received it and when you sold it? Can you implement your tax-loss harvesting strategies or, if all else fails, earmark a portion of the sale proceeds for the capital-gains tax bill that you’ll owe on your next return?
2. Sale of a second home.
You finally got tired of the constant upkeep and logistics of that vacation home, so you sold it for a tidy profit. So far, so good. But remember: if it’s not your primary residence, you’ll owe taxes on the gain. If you owned the property for less than a year, you’ll pay short-term capital gains at the same rate you’d pay on ordinary income. If you owned it for more than a year, the long-term capital gains could be as much as 20%, depending on your income level (for 2022, single taxpayers earning more than $459,750 or married taxpayers with combined income over $517,200). You may also be required to make estimated tax payments on the amount of capital gains tax you will owe.
In other words, it’s smart to discuss the impact of a planned sale with your tax and financial advisors, preferably before the closing documents are signed. You’ll also want to make sure you’ve included all your acquisition and improvement costs, because these will impact your cost basis in the property and thus, the size of the taxable gain on the sale. Don’t forget real estate fees, closing costs, and sales commissions.
3. Moving to a state with a different tax structure.
You got a considerable promotion, but it required you to relocate to a state that collects income tax—or taxes you at a higher rate than the one you left. Or maybe you’re self-employed, and you seized an opportunity that forced relocation to another state. Either way, unless you moved exactly at midnight on December 31, you’re probably going to owe taxes for a partial year in both states—assuming they both have an income tax. However, it’s worth checking the residency rules for the state you’re moving to. Some states consider you a full-year resident if you lived there for 183 days or more.
If you live in one state but work in another, you’ll want to know if the two states have a reciprocity agreement; such an agreement can allow your employer to withhold taxes in your state of residence rather than your state of employment, and you’ll have to file a return only in the state where you live. Some states require you to report your income from all sources as if you were a full-year resident, and the calculated tax is reduced based on the length of time you actually resided in the state. Others will require you to divide the income between the states before the tax is calculated. Once again, the best way to handle these questions is to anticipate them by consulting with your tax and financial advisors.
As Benjamin Franklin said in his infamous letter to Jean-Baptiste Le Roy, nothing is certain in this world except for death and taxes. However bleak this sentiment may be, the Treehouse Wealth Advisors team has a third certainty to add to this list: We will be by your side through it all —the good times and the not so good ones. Helping our clients navigate life changes is something we are passionate about and we are committed to providing our clients with the information they need to make the best decisions possible for their financial future. If you want to avoid hindsight or have a friend that needs some advice, we’re here to help.
Garrison Point Advisors, LLC doing business as “Treehouse Wealth Advisors” (“TWA”) is an investment advisor in Walnut Creek, CA registered with the Securities and Exchange Commission (“SEC”). Registration of an investment advisor does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. TWA only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of TWA’s current written disclosure brochures, Form ADV Part 1 and Part 2A, filed with the SEC which discusses among other things, TWA’s business practices, services, and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov.
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