Capital Gains (CG) is an inescapable tax burden that assails virtually every American at one point or another in their lives. At a given tax rate of between 15% to 20%, CG can be a considerable financial growth drain for anyone wanting to liquidate an asset. The asset could be one’s home, a building, or land.
The CG tax could additionally impact anyone that owns traded stocks or investments. FYI – These investments could also mean your TSP or IRA assets.
Simply put, CG is meant to be a tax on the growth of an asset. If you own something for a spell and then sell it at an amount higher than what you paid for it, that difference would be the amount that would be affected by the capital gains tax. (Bought for $100, sold for $120 = $20 in capital gains. $20 subject to CG tax between 15% and 20%).
Often, a significant portion of Capital Gains is not actual gains in value at all. It is merely a false and misleading dollar value boost from inflation! Inflation drives up the dollar value of an asset, but not its intrinsic (real) value.
In its current form, the Capital Gains Tax assesses a levy on both the intrinsic and the inflation driven values of an asset.
However, there is “something blowing in the wind” that could seriously improve the inflation portion of this wealth oppressing tax. It’s a suggestion to measure (index) the impact of inflation on Capital Gains, that could limit the taxation of “inflation growth.”
Proposal to Modify the Capital Gains Tax
Index Capital Gains and Reducing the Rates
For example, a house could double in price during the same time that inflation also doubles the prices of goods and services in an area, making the house the same real value as it was when it was purchased. However, current capital gains taxes would only see the price doubling and would tax the entire nominal dollar increase. This outrageous tax policy only serves to stifle investment and reduce the economic mobility for low- and middle-income families…Therefore, many of these families will be hit with tremendous capital gains taxes on account of inflation…Excerpts from Republican Study Committee, Fiscal Year 2020 Budget, Preserving American Freedom (page 32, “Index Capital Gains and Reducing the Rates”)
There has been a proposal to significantly modify this tax, and Americans For Tax Reform reports that there is strong support to eliminate the “inflation” aspect of this tax. The idea of removing the “inflation aspect” of the CG tax has been championed by the Republican Study Committee, Fiscal Year 2020 Budget, Preserving American Freedom (page 32, “Index Capital Gains and Reducing the Rates”)
If implemented and applied to increases within the value of qualified retirement accounts, the tax savings could potentially be significant for anyone with an IRA, 401k, TSP, etc.
How the Proposal Could Impact Investments
Why would this change be significant?
Assume you see growth (not including deposits) into your retirement account of 5% in a given year. However, inflation was 4% that year. Your actual growth was only 1% (5% – 4% = 1%) that year. Yet, for tax purposes, your account (under the current CG guidelines) grew and should be taxed at the full 5% when you make a withdrawal from the account.
In this scenario, if you are in a 20% income tax bracket when you withdraw these funds, you actually just broke even. You had a 1% gain but, would pay 1% tax on the gains (5% x 20% = 1%) (1% gain – 1% tax – 0). Uncle Sam made money from your retirement savings, but, you didn’t.
The proposal’s desired outcome would be to only apply a capital gains tax on real value increases and not inflation increases.
In addition to limiting the tax to actual gains only, the proposal also looks to drop the current capital gains tax rates from 15% to 13% and 20% to 18%.
What are the Chances of it Being Implemented?
In this current political environment when it seems virtually nothing can be agreed upon by the two quarreling factions, what chance does this unique proposition have of surviving? Actually, a pretty good one.
I think we can all agree that if we were to wait for Congress to pass legislation like this, we would likely be waiting a very long time. However, it appears the measure may not need congressional approval. There is a substantial reason to believe that the Treasury Department could implement the new “indexing” calculations without congressional support.
A quote from the article by Alex Hendrie (Americans for Tax Reform) dated May 1st, 2019:
“Under the precedent set by the Supreme Court in Chevron U.S.A. v. National Resources Defense Council (1984), the ability of Treasury to add an inflation adjustment hinges on whether a new definition of “cost” is plausible…in Mayo Foundation for Medical Education & Research v. United States (2011), the Supreme Court affirmed that the Chevron doctrine applies to Treasury regulations.”
“Cost” has different definitions where taxes are concerned, but generally “cost” means the purchase price of an item or good. However, it can include variables such as depreciation.
So, for the purposes of this measure, “Cost” is the pivotal word (in the 1984 and 2011 decision) that could allow the Treasury to change how capital gains are taxed.
Remember, capital gains are a tax on gains (Redemption value – Costs = Taxable Gains) only. If it can be determined that costs should include inflation, then based on the 1984 and 2011 Supreme Court decisions, the Treasury could make this change all on its own.
Potential for Positive Impact
I believe the first and most likely immediate place this measure’s influence would be felt would be in the securities markets. It would allow those that have been holding onto unwanted assets to be less welded to investments that would have otherwise made selling them cost prohibitive. Freeing up new investment capital may well incite the markets to recognize substantial bonus growth.
This means there is a potential for an otherwise unforeseen windfall within retirement accounts that are employing market backed securities within their portfolios. FYI – for those asking, yes, if seen in the securities markets, additional growth could also include some parts of the Thrift Savings Plan.
Secondly, the housing market could receive some additional momentum.
Without the unfair inflation portion being added to the capital gains indexing, the value of homes across the country could (and in my opinion would) see positive motion.
More potential homeowners and investors would dip their toes into the market if they knew they would be able to turn a profit and not get hit with the current inflation tax attached to the sale of properties and homes. The housing market would be able to experience a resurgence in home and property values as more owners would be willing to sell knowing they would be able to keep more of the proceeds in their own pockets.
I could foresee a financial “snowball” impacting many aspects of the U.S. economy.
More loosening of money in the securities market, combined with more liquidity within the housing markets, could also lead to increased consumer spending.
Jobs and Productivity
Stronger economy, more freed up funds, and increased consumer spending would possibly put more venture capital in play. This could add more jobs and increase U.S. productivity. More jobs would put workers in a stronger bargaining position than they have been in for decades.
And, in my opinion, wages would likely see substantial growth as well. It’s as simple as supply and demand. More jobs than available workers = greater competition between employers and improved prosperity for the lower and middle classes.
Any opinions expressed in the article are those of the author alone. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risks, including the loss of principal. No strategy assures success or protects against loss. Silverlight Financial, Infinity Financial Services and its affiliates do not provide tax, legal or accounting advice. This material is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. For a list of states in which I am registered to do business, please visit www.silverlightfinancial.com.