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When Protecting Assets Beware of Capital Gains

         When we get calls with questions about how to protect assets from being spent towards long term care #longtermcareplan or how to protect an estate by minimizing or eliminating an estate tax the focus is limited to the value of the asset.  In the case of asset protection a typical fear is that Mom does not want the State or the nursing home to take her home, which let’s say she could sell for $600,000.  When considering estate tax, she might be thinking about transferring her home to reduce the size of her estate by that same $600,000 and thus reduce the estate tax.

          However, so many times when I mention that capital gains tax has to be considered I encounter some puzzling looks.  That’s because many people forget about – or don’t really understand the impact of – this tax.  It is like a silent assassin lurking in the shadows.  Before I explain how so, let’s review what it is.

           Capital gain #CapitalGains is the difference between the “basis” in property and its selling price.  Capital gain applies to property that appreciates – increases in value – over the time that you owned it, such as real estate and stocks.  For example, if you purchased a house for $200,000 and later sold it for $350,000 you would have a gain of $150,000.  The basis starts out at $200,000, but can be adjusted upwards if you spend money making capital improvements.  For instance, if after buying the house you spent $50,000 updating the kitchen, the basis would be adjusted to $250,000 and the gain on the sale at $350,000 would be reduced to $100,000.

            The capital gain is included in your income in the year that you sold the property.  It is called a “realized gain” and is subject to payment of income tax.  Capital gains, however, are generally taxed at a lower rate than regular income such as wages and interest earned on bank accounts.  Capital gains, for most people, are taxed at 15% or 20%, depending on how high their income tax bracket is.

            Now that we have a general understanding of how capital gains tax works next week we’ll review some exceptions to the capital gains tax and why it is so insidious when we look to do long term care and/or tax planning.