Washington state’s new capital gains tax has brought unwelcome and surprise tax bills to many Washington state residents. With any new tax, it is important to understand both how the tax works, and how it applies to your personal finances. This will allow you to correctly report and pay your tax bill and minimize the taxes that you will owe.
Understanding the WA State Capital Gain Tax
The Washington state capital gains tax went into effect in 2022 and is a very different capital gains tax than what is found in the Federal tax system. It requires a whole new level of understanding and planning for proper tax management.
What is the tax?
- The Tax: The tax is 7% on long-term capital gains. It applies to all Washington state residents or for the sale of specific assets sold in Washington by non-residents. The tax is on individual tax returns only and does not apply to business entities. It is limited to long-term capital gains, specifically excluding short-term capital gains.
What are the deductions?
- The Standard Deduction: The standard deduction for 2023 is $262,000, and therefore only gains above that amount are taxed. This deduction is the same for both individuals and couples. Couples filing jointly receive the full deduction, while couples filing separately split the $262,000 deduction amount. The standard deduction is adjusted annually for inflation and started at $250,000 in 2022.
- The Charitable Deduction: There is a charitable deduction up to a maximum of $105,000. Only gifts to WA state based charities will qualify, and the charitable deduction has its own standard deduction. This means only charitable donations in excess of $262,000 are deductible.
What are the exemptions?
- The Real Estate Exemption: The most impactful exemption from this tax is capital gains from the sale of real estate, both personal and investment real estate. This also includes gains from real estate transactions within a private entity.
- The Family Business Exemption: Another important exemption is for qualified, family-owned small businesses. This exempts capital gains from the sale of family businesses with less than $10,480,000 in revenue. The qualifications for this exemption are more complicated than I am covering here so be sure to consult with your CPA to find out if your business qualifies.
- Other Exemptions: There are also exemptions for timberland, timber, and livestock along with several other more nuanced items.
When are tax payments due?
- The Tax Filing Date: Taxes are due on April 15th of the following year and estimated payments are not required. Late payments have a penalty of up to 29% and there is an option to file for an extension, but this penalty still applies to any late payment amount.
5 Strategies to Manage and Reduce Your Washington State Capital Gain Tax Bill
The following 5 tax planning strategies can help a taxpayer minimize their WA state capital gains tax bill. Each strategy has multiple other details which should be considered beyond what is listed here. Be sure to consult with your CPA on any of these strategies that you think may be a good option for your taxes.
Harvest Long-term Losses
WA state taxpayers can use capital losses to offset capital gains on their tax return to reduce taxes. Not all losses are eligible for WA state capital gains returns, only long-term losses can be used. Some capital losses may happen naturally, however, to go even further an investor can actively look for investments at a loss to sell and “harvest” the loss for their tax return. Some investment strategies do this automatically seeking to provide an added tax benefit to investors. Be careful when harvesting losses so that they are of the long-term variety and that the investment is not repurchased before 31 days or it will cause a “wash sale” and cancel the loss.
Spread Sales of an Asset Across Multiple Tax Years
The large standard deduction for this tax creates a specific planning opportunity. A large asset sale in a single year only has access to that year’s standard deduction. If the assets being sold can be broken into multiple sales over multiple years, the realized gain is also spread out over multiple years. This allows the gain to be spread out over multiple standard deductions and potentially reducing or eliminating the tax.
Example: Sale of Amazon stock. If a sale of Amazon stock totaled $600,000 in long-term capital gains, it would be over the standard deduction resulting in a tax bill of $23,660. If that same sale was split into three sales, each one in a separate year, the yearly gain of $200,000 would be below the standard deduction resulting in no tax.
Sell an Investment with an Installment Sale
An installment sale is an asset sale when instead of being paid up front, cash is paid to the buyer in a series of payments. When structured properly the gain is realized in pieces with each payment. This works similarly to the last strategy because it spreads the realized gain out over multiple tax years and the taxpayer may be able to take advantage of multiple standard deductions.
Gift to Washington State Charities
The only available deduction outside of the standard is a charitable deduction. This deduction allows for a write-off of up to $105,000 for giving. However, the charitable deduction only applies for giving in excess of $262,000, and only Washington state based charities are eligible. A strategy that works well is to accelerate several years of giving into a single year when asset sales take place. This can help boost a taxpayer’s giving levels high enough to qualify for the deduction.
If Moving to Another State, Consider Waiting to Sell
If moving to a new state is in your future, it may make sense to delay selling until after the move. Currently this tax only applies to Washington state residents, and unlike some state taxes there are no clawback regulations for past residents. There are multiple other factors that should be considered before doing, including if the state being moved to has a state capital gains tax which might be higher than the WA state tax.
Conclusion
I hope this helps to guide you in your efforts to navigate the new Washington State capital gains tax. Understanding the tax will help with planning your financial life in a way that will minimize the tax and to pay it in accordance with the current laws.