Understanding Capital Gains: What Investors Need to Know for Smart Wealth Management

Tax season arrives every April, putting capital gains taxes into sharp focus for high-net-worth investors. While we arent’ tax advisors, we often remind clients that effectively managing capital gains can positively influence their wealth strategy, though outcomes, of course, depend on individual circumstances. Knowing how gains are taxed and strategically planning for them may help protect wealth and improve investment returns.

What Are Capital Gains?

Capital gains occur when you sell an investment for more than its purchase price. They’re realized when profits are made on stocks, bonds, real estate, or other assets.

There are two types of capital gains:

• Short-term capital gains: Realized when assets are held for one year or less. These gains are taxed at your ordinary income tax rate, which can be quite high for affluent investors, as much as 37% for single filers making $609,351 or more in the 2024 tax year.
• Long-term capital gains: Realized after holding assets more than one year. These typically receive favorable tax treatment, often at lower tax rates (0%, 15%, or 20%), depending on your taxable income.

Stated another way, capital gains occur when someone sells an investment, such as stocks, bonds, or real estate, for a profit. Short-term gains (assets held less than one year) are taxed at higher rates, while long-term gains benefit from lower, preferential tax rates. The key aspect here is the selling of the investment for a profit. If an investor sells an investment at a lower price than the purchase price, that’s a capital loss, which can be beneficial from a tax perspective, though it’s a topic for a separate piece.

Understanding the difference between short and long-term capital gains helps you optimize investment decisions for tax efficiency, directly improving your portfolio’s performance and long-term returns.

Capital Gains Considerations for High-Net-Worth Investors

For affluent investors, tax-conscious investing is essential. Taxes can drastically reduce investment returns over time if not managed carefully. Individual circumstances will vary, but high-net-worth individuals might consider the following strategies based on their specific financial situation:

• Asset location: Placing less tax-efficient investments (such as bonds or actively managed funds) in tax-deferred accounts like IRAs or 401(k)s, and more tax-efficient investments (stocks, ETFs) in taxable accounts.
• Rebalancing strategies: Maintaining your desired asset allocation often involves selling investments, triggering capital gains. Timing and method can significantly affect taxes.

Strategies to Manage Capital Gains in Your Investment Plan

Implementing smart strategies like the following may help minimize capital gains taxes.

Harvesting Gains and Losses:

Strategically sell losing investments to offset realized gains, reducing taxable income.

Using Tax-Advantaged Accounts:

Accounts like Roth IRAs, traditional 401(k)s, and Health Savings Accounts (HSAs) can defer or eliminate taxes on gains.

Investing in Tax-Efficient Funds:

ETFs and index funds typically have lower turnover rates, minimizing annual taxable distributions.

Long-term Investing:

Frequent trading can trigger short-term gains, taxed at higher rates. Holding investments longer generally provides more favorable tax treatment.

The Role of a Registered Investment Advisor (RIA) in Capital Gains Planning

Registered Investment Advisors (RIAs) provide guidance to investors, helping them navigate complex financial strategies. Though RIAs do not provide direct tax advice, they:

• Help investors structure portfolios to be tax-efficient.
• Coordinate with CPAs to align investment decisions with broader financial and tax goals.
• Monitor portfolios regularly to identify opportunities for tax optimization.

Final Thoughts & Next Steps

Effectively managing capital gains is key to preserving and growing wealth over time. We have found that it is beneficial for high-net-worth investors to regularly review investment plans based on their unique goals and circumstances.

We encourage you to schedule a capital gains strategy consultation with Watts Gwilliam today. Depending on your goals and circumstances, our advisors may be able to help you refine your investment approach and improve your tax efficiency with an eye toward long-term wealth preservation. Proactive planning today can help you keep more of your wealth tomorrow.

Disclosure
This content is for informational purposes only and should not be considered financial, tax, or legal advice. Individual circumstances vary, and tax and estate laws are subject to change. Consult a qualified professional before making any decisions. Watts Gwilliam & Company is an SEC-registered investment advisor; registration does not imply a certain level of skill or training. We act as fiduciaries, prioritizing clients’ best interests and fully disclosing any material conflicts of interest. Investing involves risk, including potential loss of principal. Past performance is not indicative of future results.