President Donald Trump said this week that his government is looking at lowering capital gains taxes. It’s unclear if the administration will support legislative initiatives to reduce the capital gains tax, or whether it will continue to consider indexing the basis of capital gains for inflation. The purpose, according to Treasury Secretary Steve Mnuchin, is to set a contrast with former Vice President Joe Biden, who is seeking to boost capital gains taxes, while also assisting the economy in its recovery from the COVID pandemic.
Individuals’ capital gains (or losses) are calculated under present legislation by subtracting the difference between the asset’s sale price and its basis (the value of the asset when it was acquired). Real increases in value, inflation, or both may cause an asset to generate again. Capital gains taxes are inflated to the degree that inflation contributes to a taxpayer’s capital gains.
Taxpayers would be able to amend the basis to account for changes in the price level over time if the basis was indexed for inflation. As a result, capital gains taxes would only be imposed on real gains.
Are capital gains inflation-adjusted?
UNITED STATES OF AMERICA, WASHINGTON, D.C. Senator Ted Cruz (R-Texas) and Representative Warren Davidson (R-Ohio) proposed the Capital Gains Inflation Relief Act today, legislation that would ensure that an individual’s cost basis in a capital asset is treated equally to other parts of the tax law by indexing the basis for inflation. Inflation has grown by 5.4 percent since September 2020, according to the US Bureau of Labor Statistics, matching the highest rate since 2008.
Senators Thom Tillis (R-N.C.), Mike Braun (R-Ind. ), John Barrasso (R-Wyo. ), Pat Toomey (R-Pa.), Jim Inhofe (R-Okla.), and James Lankford (R-Okla.) are among the bill’s cosponsors (R-Okla.). Senator Cruz first proposed this measure in 2018.
“The Biden administration’s inflation crisis is driving prices to increase, eroding Americans’ hard-earned cash’ purchasing power.” We shield hardworking Americans from the brutal inflation tax generated by this administration’s reckless spending by indexing the cost basis of capital assets to inflation. This law would encourage individuals to save for things like a child’s college education and retirement, as well as help job creators hire more people and improve wages at a time when Americans are in desperate need. As this government attempts to destroy Americans’ wealth, I will continue to lead the battle in the Senate for a fairer, simpler tax code and economic prudence.”
“As Biden’s economy continues to deteriorate, Congress must do all possible to defend the value of Americans’ hard-earned money.” “A simple first step to protect Americans from the invisible penalty of inflation is to adjust the tax law to account for growing prices by indexing the tax basis of capital gains for inflation.”
“Senator Cruz should be applauded for bringing the Capital Gains Inflation Relief Act back to the Senate floor. Not only does this bill put an end to the unfair practice of taxing inflationary gains, but it also encourages saving, investment, and innovation, all of which will help the economy expand. It is always a good idea to index capital gains to inflation, but today, more than ever, it is critical to do so because of Joe Biden’s inflation.”
BACKGROUND
Currently, the Treasury Department calculates capital gains taxes based on the sticker price at the time of purchase, rather than the asset’s inflation-adjusted cost in today’s currency. As a result, even if the item’s value just increased and kept pace with inflation, an individual who sells a capital asset must pay tax on the gain.
The Capital Gains Inflation Relief Act indexes certain assets to inflation for the purposes of determining a gain or loss, ensuring that the capital gains tax is treated fairly in comparison to other parts of the federal tax code, such as individual income tax brackets, the standard deduction, and income thresholds for certain tax credits. Sen. Cruz’s previously filed proposal has been modified to incorporate digital assets like cryptocurrencies and non-traditional currencies (NFTs).
What are index capital gains, exactly?
The CBDT has set the ‘Cost Inflation Index (CII)’ for FY 2021-22 (AY 2022-23) at 317, up from 301 for FY 2020-21 (AY 2021-22), to determine ‘long term capital gains (LTCG)’ under Income Tax.
What is the advantage of indexation in capital gains?
Indexation is the process of recalculating the purchase price after factoring in the inflation index released by the Internal Revenue Service. The capital gain is lowered since the purchase price is adjusted for inflation. Investors can profit from indexation when it comes to LTCG for non-equity funds.
Are you subject to inflation taxes?
I estimated that the public held around $22.8 trillion in interest-bearing non-inflation-protected US government securities at the end of the second quarter of 2021. The wealth transfer generated by an inflation rate of 5.4 percent when businesses and households expected inflation of 2 percent is roughly 3.4 percent times the value of outstanding government debt, or about $775 billion, using 2 percent as an approximation for the average interest yield on these securities. With inflation expected to reach 5.4 percent in 2021, the inflation tax will shift $1.875 trillion in purchasing power from firms and families to the federal government in total.
Who benefits from inflation?
In general, those with a flexible income, such as businesses, dealers, merchants, and speculators, benefit from inflation because of windfall profits that result from prices rising faster than costs.
What are my options for avoiding capital gains tax?
Here are five tax planning strategies for reducing or eliminating CGT on long-term capital gains, which are net profits on investments held for more than a year, as well as their benefits and drawbacks:
Stay in a lower tax bracket
You may not have to worry about CGT if you’re retired or in a lower tax rate (less than $75,900 for married couples in 2017). Other tax deductions (e.g., mortgage interest, medical costs) can help you stay below the threshold.
Even if you fall into this category, you must be cautious about the number of assets you sell at once in relation to your overall income (e.g., from part-time job) to avoid being pushed into a higher tax rate.
Furthermore, because this tax statute only applies to federal taxes, you may still be required to pay state income taxes. It’s possible that taking advantage of this tax break will affect your eligibility for additional tax credits or social security payments.
Harvest your losses
Capital gains might be mitigated by selling “losers” in your stock portfolio. If your losses exceed your gains, you can deduct up to $3,000 every year and carry the balance forward to the next year.
The difficulty with this method is that your losses must exceed your gains meaning you won’t make any money and the $3,000 annual cap isn’t much if you have a large portfolio.
Not to mention, letting go of what look to be losers in such a volatile market when you have no visibility into how they’ll perform the following day or the next month could be a risky move.
Gift your stock
You can give up to $15,000 worth of stock to a family member in a lower tax rate (e.g., a child or a retired parent) so that they don’t have to pay CGT when they sell the stock.
You can also donate appreciated stock to charities to avoid CGT and receive an income tax deduction for the stock’s fair market value.
Gifting regulations have been changing a lot recently (for example, the new tax law that applies trust tax rates to “kiddies”), and there’s a limit to how much you can give, so make sure you’re up to date before distributing your assets.
Move to a tax-friendly state
It may appear that relocating solely to avoid paying capital gains taxes is a bit extreme. Consider deferring a sale if you expect to move to a state without an income tax, such as Florida or Nevada, so you don’t have to pay a state CGT.
Relocating your house and uprooting your family is, of course, impractical for the majority of individuals. Furthermore, there is no guarantee that a state that is tax-friendly today will not impose a state CGT tomorrow!
Invest in an Opportunity Zone
Three significant tax benefits can be obtained by investing in an Opportunity Zone fund.
- If profits are reinvested and held in an Opportunity Zone, any 2018 capital gains are deferred for a further eight years.
- If the investment is held for five or seven years, the amount of capital gains taxes is reduced by 10% and 15%, respectively.
- If you hold an investment for ten years, you’ll get a full exemption from capital gains tax on all future capital gains on the invested money, commencing in 2018.
The purpose of these funds is to encourage investments in housing, small companies, and infrastructure in economically distressed communities throughout the United States.
You can roll capital gains from the sale of other assets, such as real estate and bonds, into an Opportunity Zone investment in addition to stock gains.
Because the types of firms eligible for Opportunity Zone financing are so diverse, you can choose low-risk, high-return investments.
One of the most high-yielding tactics to take advantage of this new tax package is to buy older buildings in Opportunity Zones, renovate them at a reinvestment cost, and then manage them as rental properties.
Due to their location, Opportunity Zones offer the opportunity to purchase homes that are far less expensive than those in other parts of the country.
However, not all opportunity zones are made alike, and there are a number of places that qualify for opportunity zone investing and have a lot of upside potential, such as Puerto Rico, which is a rising vacation destination with high rents.
Investing in Opportunity Zone funds is by far the most basic, adaptable, and profitable option to make your taxes work for you rather than merely passing them over to the government, with no limits on the amount you can invest or the state in which you live.
How is the capital gain index calculated?
It is a measure of inflation used in tax legislation to calculate long-term capital gains on the sale of assets. The index is defined under Section 48 of the Income-Tax Act as what is notified by the Central Government every year, taking into account 75% of the average rise in the consumer price index (CPI) for urban non-manual employees for the previous year. As a result, if the price of a capital asset has risen in lockstep with the base price, the cost allowed to sell an asset and replace it, even after indexation, will be less than the price payable for a new asset. However, the price rise for many capital assets is less than the market price, and in many situations, it is more.
What role does the Cost Inflation Index (CII) play in calculating capital gains? As you may be aware, capital gain occurs when the net sale consideration of a capital asset exceeds the cost. Because “cost of acquisition” is a historical figure, the concept of indexed cost allows the taxpayer to account for inflation. As a result, capital gains are taxed at a lesser rate than if historical cost was factored into the calculations.
(Index for the year of sale/Index for the year of purchase) x cost is the formula for calculating indexed cost.
For example, if a home acquired for Rs 20 lakh in 1991-92 was sold for Rs 80 lakh in 2009-10, the indexed cost would be (582/199) x 20 = Rs 58.49 lakh. Long-term capital gains will be Rs 21.51, or Rs 80 lakh less Rs 58.49 lakh.
What is the formula for the capital gain index?
Consider the following example to learn how to calculate cost inflation index:
On August 1, 2004, I paid Rs. 30 lakhs for a property.
On April 1, 2018, the property was sold for Rs. 85 lakhs.
What exactly do you mean when you say index?
An index is a metric or indicator of something. It usually refers to a statistical measure of change in a securities market in finance. Stock and bond market indexes, in the case of financial markets, are made up of a hypothetical portfolio of securities that represent a specific market or sector of it. (Indexes cannot be purchased directly.) The S&P 500 Index and the Bloomberg US Aggregate Bond Index are popular stock and bond market benchmarks in the United States.