2021 Year-End Tax Planning for Investors and Estate/Gift Planning

2021 has been another unpredictable and memorable year.  With all of the changes and proposed legislation to come, we have outlined a few 2021 year-end tax planning strategies for investors and individuals with estate and gift planning needs below.

Securities Sales

Traditionally, investors time sales of assets like securities at year-end for optimal tax results. For starters, capital gains and losses offset each other. If you show an excess loss for the year, you can then offset up to $3,000 of ordinary income before any remainder is carried over to the next year. Long-term capital gains from sales of securities owned longer than one year are taxed at a maximum rate of 15% or 20% for certain high-income investors. Conversely, short-term capital gains are taxed at ordinary income rates reaching as high as 37% in 2021.

YEAR-END MOVE: Review your portfolio. Depending on your situation, you may want to harvest capital losses to offset gains or realize capital gains that will be partially or wholly absorbed by losses. For instance, you might sell securities at a loss to offset a high-taxed short-term gain.

Be aware of even more favorable tax treatment for certain long-term capital gains. Notably, a 0% rate applies to taxpayers below certain income levels. Furthermore, some taxpayers who ultimately pay ordinary income tax at higher rates due to their investments may qualify for the 0% tax rate on a portion of their long-term capital gains.

However, watch out for the “wash sale rule”. If you sell securities at a loss and reacquire substantially identical securities within 30 days of the sale, the tax loss is disallowed. A simple way to avoid this harsh result is to wait at least 31 days to reacquire substantially identical securities.

The preferential tax rates for long-term capital gains also apply to qualified dividends received in 2021. These are most dividends paid by U.S. companies or qualified foreign companies.

Tip: Some of the new legislative proposals have included a higher capital gains rate effective in 2022, or possibly earlier, so the status of pending legislation should also be considered before making any investment decisions.

Required Minimum Distributions

Normally, you must take “required minimum distributions” (RMDs) from qualified retirement plans and traditional IRAs after reaching age 72 (70½ for taxpayers affected prior to 2020). The amount of the RMD is based on IRS life expectancy tables and your account balance at the end of last year. If you do not meet this obligation, you owe a tax penalty equal to 50% of the required amount (less any amount you have received) on top of your regular tax liability.

The CARES Act suspended the RMD rules for 2020—but for 2020 only. The RMD rules are reinstated for this year.

YEAR-END MOVE: Make arrangements to receive RMDs before January 1, 2022. Do not procrastinate. If you wait too long, you may miss the December 31 deadline if the financial institution cannot accommodate you quickly enough or you run into other complications.

As a general rule, you may arrange to receive the minimum amount required, so you can continue to maximize tax-deferred growth within your accounts. However, you may decide to take larger distributions—or even the full balance of the account—if that suits your needs and depending on your tax situation and the potential impact of any enacted changes in tax rates.

Tip: The IRS has revised the tables for 2022 to reflect longer life expectancies. This will result in smaller RMDs in the future.

Net Investment Income Tax

Moderate-to-high income investors should be aware of an add-on 3.8% tax that applies to the lesser of “net investment income” (NII) or the amount by which MAGI for the year exceeds $200,000 for single filers or $250,000 for joint filers. (These thresholds are not indexed for inflation.) The definition of NII includes interest, dividends, royalties, capital gains and income from passive activities, but not Social Security benefits, tax-exempt interest and distributions from qualified retirement plans and IRAs.

YEAR-END MOVE: After a careful analysis, estimate both your NII and MAGI for 2021. Depending on the results, you may be able to reduce your NII tax liability or avoid it altogether.

For example, you might invest in municipal bonds (“munis”). The interest income generated by munis does not count as NII, nor is it included in the calculation of MAGI. Similarly, if a passive activity qualifies as an active business, the resulting income may be exempt from the NII tax.

Tip: A recent version of the BBB Act, if passed, would classify income received from passthrough entities as investment income subject to the NII tax even if you materially participate in the business. 

Section 1031 Exchanges

Beginning in 2018, the TCJA generally eliminated the tax deferral break for Section 1031 exchanges of like-kind properties. However, it preserved this tax-saving technique for swaps involving investment or business real estate. Therefore, you can still exchange qualified real estate properties in 2021 without paying current tax, except to the extent you receive “boot” (e.g., cash or a reduction in mortgage liability).

YEAR-END MOVE: Make sure you meet the following two timing requirements to qualify for a tax-deferred Section 1031 exchange.

  • Identify or actually receive the replacement property within 45 days of transferring legal ownership of the relinquished property.
  • Have the title to the replacement property transferred to you within the earlier of 180 days or your 2021 tax return due date, plus extensions.

Note that the definition of “like-kind” may include, for example, an exchange of an apartment building for a warehouse or even raw land, depending on the particular facts.

Tip: Some proposals, if enacted, would restrict this tax break for real estate. If this technique appeals to you, discuss the current status of these proposals with your tax advisor.

Estate and Gift Taxes

The TCJA doubled the federal estate tax exemption from $5 million to $10 million for 2018 through 2025, with inflation indexing. The exemption is $11.7 million in 2021. The table below shows the progression of the exemption and top estate tax rate for the last ten years.

Tax year  Estate tax exemption Top estate tax rate
2012 $5.12 million 35%
2013 $5.25 million 40%
2014 $5.34 million 40%
2015 $5.43 million 40%
2016 $5.45 million 40%
2017 $5.49 million 40%
2018 $11.18 million 40%
2019 $11.40 million 40%
2020 $11.58 million 40%
2021 $11.7 million 40%


YEAR-END MOVE: The increased exemption amount shown above for 2018-2021 is scheduled to end in 2025, but some proposals, if enacted, could make this reduction effective as of January 1, 2022, along with other unfavorable changes to current estate and gift tax rules.  Some changes could even be effective this year so you should consult your estate planning advisor for the current status of these proposals if you are interested in revisiting your estate plan.

Furthermore, you can give gifts to family members that qualify for the annual gift tax exclusion. For 2021, there is no gift tax liability on gifts of up to $15,000 per recipient ($30,000 for a joint gift by a married couple). This reduces the size of your taxable estate. You may “double up” by giving gifts in both December and January that qualify for the annual gift tax exclusion for 2021 and 2022, respectively.

  • Contribute up to $19,500 to a 401(k) in 2021 ($26,000 if you are age 50 or older). If you clear the 2021 Social Security wage base of $142,800 and promptly allocate the payroll tax savings to a 401(k), you can increase your deferral without any further reduction in your take-home pay.
  • Sell real estate on an installment basis. For payments over two years or more, you can defer tax on a portion of the sales price. This may effectively reduce your overall tax liability (subject to potential increases in tax rates in future years).
  • Consider investing in a Qualified Opportunity Fund (QOF) to take advantage of the opportunity to defer paying tax on eligible capital gains realized during the year that are reinvested into a QOF. Additional tax breaks are available for QOF investments, so consult your tax advisor to discuss the tax savings opportunities as well as eligibility restrictions associated with QOFs.
  • Weigh the benefits of a Roth IRA conversion, especially if this will be a low-tax year. Although the conversion is subject to current tax, you generally can receive tax-free distributions in retirement, unlike taxable distributions from a traditional IRA.
  • From a tax perspective, it is often beneficial to sell mutual fund shares before the fund declares dividends (the ex-dividend date) and to buy shares after the date the fund declares dividends, if you are planning to buy or sell a particular mutual fund.
  • Consider a qualified charitable distribution (QCD). If you are age 70½ or older, you can transfer up to $100,000 of IRA funds directly to a charity. Although the contribution is not deductible, the QCD is exempt from tax. This may improve your overall tax picture.
We Are Here to Help

Maxwell Locke & Ritter can help you with any questions you might have regarding the items above.  Please contact us if you have questions about these updates.

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