Coauthored by Leslie Hurt, Tax Principal and Kevin Zhang, Tax Senior
Traditionally year-end is a time when many people review investments and consider transactions to lock in tax savings or benefits for the year. As the Washington state capital gains tax appears to be here to stay, there are some additional year-end considerations (which may differ from federal tax treatment) for Washington residents and those who hold property within the state.
1. Check in with investment advisors now on the total year-to-date long-term capital gains and losses. Be aware of the $250,000 annual exemption threshold and consider recognizing long-term losses before year end to offset the long-term gains:
It is crucial to maintain regular communication with investment advisors to assess the year-to-date (YTD) long-term gains and losses within the investment portfolio. This proactive approach allows investors to stay informed about the performance of their investments and make strategic decisions based on the current market conditions. By knowing the YTD long-term capital gains and losses, investors can work with their CPAs and investment advisors to implement tax-efficient strategies, such as harvesting long-term capital losses to offset long-term gains and potentially reduce their overall federal and Washington state tax liability. By carefully considering the threshold and planning for potential losses, investors can make strategic decisions to achieve a favorable tax outcome.
2. Check in with the contact persons of all partnership/LLC investments to confirm any anticipated long-term gains from non-real estate source:
For individuals invested in partnerships/LLCs, it is essential to reach out to their contact person of such investments to confirm any potential net long-term gains derived from the non-real estate investments. The partnership and LLC K-1s provide detailed information about the income, deductions, and credits allocated to each partner, including any long-term capital gains. By proactively confirming this information, investors can plan accordingly for tax implications before the year-end. Understanding the nature and amount of such expected long-term capital gains allows investors to make timely decisions on their tax strategy.
3. If you have large unrealized short-term capital losses and the investments have been held for close to a year, consider holding such investments until it is held for more than a year, and sell before year end:
In situations where there are substantial unrealized short-term capital losses embedded in the investment portfolio held for nearly a year, we recommend a strategic approach evaluating the federal and Washington state pros and cons of holding such investment(s) for a few more weeks and then disposing before the year-end. This decision, driven solely by tax considerations rather than economic considerations, aims to shift the investments into the long-term category. By holding any capital investment for at least 12 months, the losses become eligible for the more favorable long-term treatment, and such long-term losses could be used to offset any long-term capital gains derived during the tax year, which will reduce the overall Washington long-term capital gains tax liability.
4. If your domicile changed earlier in the year, it is crucial to maintain proper documentation on such change and to account for the long-term capital gains derived between the new state of domicile and the prior state:
If a domicile change occurred earlier in the year, attention to proper documentation is crucial. (Domicile is the place a person considers their permanent and primary home; capital gains from intangibles are subject to Washington tax only if the seller is domiciled in Washington at the time of sale.) This documentation should thoroughly substantiate the change, including evidence of the new primary residence, voter registration, and other tangible indicators that the new domicile has been established and that ties with the prior domicile have been severed.
Additionally, it is important to account for any capital gains that may have been incurred between the new state of domicile and the prior state. Understanding and documenting this change, and accounting for the allocation of capital gains, are vital due to variations in state tax laws which may impose different tax treatments on capital gains. Proper documentation and allocation of capital gains between the two states can prevent taxpayers from inadvertently paying too much (or too little) Washington tax.
5. Be aware of the strict charitable contribution rules, minimum and threshold, and Washington state “principally directed or managed” requirement (This is especially important for Donor Advised Funds):
Individuals should consider utilizing charitable donations to further reduce their Washington long term capital gain tax after the $250,000 annual standard deduction is reached. In relation to the Washington state capital gain charitable donation deduction, individuals can claim a modest deduction—but certain rules apply. The deduction is applicable only to charitable gifts in excess of the $250,000 annual standard deduction, with the deductible amount capped at a maximum of $100,000. The maximum allowable deduction of $100,000 results in a potential maximum tax savings of $7,000 under the current Washington state capital gain tax regulations.
Many individuals either already have a donor-advised fund or might think about setting up one in the future. If you want to receive a Washington state tax deduction for donating to a charity, such charity needs to be principally directed or managed in Washington state under the current regulations. However, many donor-advised funds don’t meet this rule. Hence, it’s a good idea for people to think about how they want to give to charities in the future and where their fund should be set up, so they can get the most benefit from this tax deduction.
6. Making gifts using Irrevocable Non-Grantor Trusts to avoid the $250,000 limit. This is significant in light of estate planning strategies this year and as we approach the 12/31/25 sunset:
The 2017 Tax Cuts and Jobs Act (TCJA) nearly doubled the lifetime estate and gift tax exemption from $5.6 million for individuals and $11.18 million for couples, to $12.92 million per person and $25.84 million for a married couple in 2023. Individuals who are interested in passing on wealth to their family and looking for ways to reduce their Washington capital gain tax should consider making gifts to family members by utilizing irrevocable non-grantor trusts. This strategy can be employed to reduce exposure to the existing $250,000 capital gain annual exclusion limitation. Irrevocable non-grantor trusts, once established, remove the assets from the grantor’s estate, providing potential federal and Washington estate tax and Washington capital gains tax advantages.
Keep in mind that the current lifetime estate and gift tax provisions under the TCJA are scheduled to sunset, or expire, at the end of 2025. It is highly recommended for individuals who are interested in making a large gift to work closely with their CPAs, in conjunction to their legal and financial advisors, to navigate the intricacies of trust structures, ensuring compliance with tax laws and achieving the desired estate planning goals.
With the year coming to a close, take stock of your financial situation and the planning tools available for you to leverage. Please contact a Clark Nuber professional if you have any questions on Washington Capital Gains Tax.
© Clark Nuber PS, 2023. All Rights Reserved.