Washington State’s 7% capital gain tax passed into law in 2021. Though it was challenged in court as unconstitutional (Washington’s state constitution prohibits income tax), the Washington State Supreme Court ruled on March 24, 2023 that it an excise tax on the sale of certain long-term assets, not an income tax, and is therefore constitutional.
Here’s what you need to know, what you can do to prepare, and a few ideas to reduce or avoid the tax.
What is the tax rate?
Washington State residents pay a 7% tax on long-term gain from the sale of certain assets after exemptions and deductions.
When does it start?
The tax applies to assets sold after January 1, 2022 – the tax does not apply to capital gains realized in 2021.
Who pays the tax?
All Washington State residents are subject to the tax. Those outside the state are not generally subject to the tax unless selling tangible personal property inside the state.
Corporations and other entities are not subject to the tax, but owners receiving a capital gain allocation from pass through entities like S Corps, LLCs, and Partnerships would personally pay tax on their portion of the gain.
What assets are taxed?
The tax applies to certain long-term capital gain assets only – assets sold after being held longer than 1 year. Short-term gain, ordinary income, interest, and qualified dividends are not subject to the tax.
What deductions apply?
The first $250,000 in long-term gain is exempt from tax each year for each individual and married couple. Married couples share a single deduction $250,000.
Long-term gain from the sale or transfer of “substantially all” (at least 90%) of an individual’s interest in a qualified family-owned small businesses with less than $10,000,000 annual revenue can also be deducted.
Finally, an additional charitable deduction is available of up to $100,000 if total charitable contributions exceed $250,000. So, to get the full $100,000 deduction, you would need to make total charitable contributions of $350,000.
What assets are excluded from the tax?
In addition to the $250,000 standard deduction detailed above, gain on some assets is exempt from the tax altogether, including:
- Real estate and gains from privately held entities directly attributable to a real estate sale
- Retirement accounts
- Certain livestock
- Certain timber, timberland, and agricultural land, including dividends from real estate investment trusts derived from the sale of timber or timberlands
- Commercial fishing privileges
Can I use short-term capital losses to reduce long-term gain?
No. Because Washington State only taxes long-term capital gain, short-term gains and losses are ignored entirely.
What can I do to avoid the Washington State capital gain tax?
As always, we start with your goals. Why are you selling this asset? To support your living expenses? Provide for family and loved ones? Support causes you care about?
Depending on your goal, consider these strategies to reduce the tax impact on your planning. And for more ways to be a tax-smart investor, see A Guide to Tax Efficient Investing.
I’m selling assets to support my living expenses
- Spread your gain out over multiple years. You can take up to $250,000 free of Washington State capital gain tax each year, so plan ahead to stay under that limit whenever possible.
- Increase portfolio income to limit capital gains. If you’re selling stock each year to provide income, look instead for opportunities to allocate toward higher income-producing stocks this year, allowing you to live more on income and less on sale proceeds.
- Leave Washington State. It sounds extreme, but if you’ve exhausted all other options, consider establishing residency in a lower tax state, as we discuss in Should I Leave Washington State to Avoid the Estate Tax?.
I’m selling assets to provide for my family and loved ones
- Gift appreciated assets to lower-income family members. Rather than selling assets and giving proceeds to loved ones in need, gift appreciated stock or other assets directly to them. When they sell, they’ll be able to use their own $250,000 deduction before any tax applies.
I’m selling assets to give to causes I care about
- Give stock or assets directly. Most charitable organizations can receive stock or other highly-appreciated assets directly, then sell them tax-free. So rather than selling an asset and giving the cash, give the asset directly.
- Gift appreciated assets to a Donor Advised Fund. Asset sales inside a Donor Advised Fund are tax-free and you can give proceeds to almost any qualified charity, minimizing tax and increasing the impact of your gift.
- Make larger contributions to a Charitable Remainder Trust. This strategy can help reduce or eliminate taxes on sales of highly appreciated assets, provide income for you today, and give to charity at your death.
The 7% capital tax applies to all Washington State residents, but you can make moves to eliminate or at least significantly reduce the tax with a carefully designed comprehensive plan and stretch your hard-earned dollar further! For more detail on the tax, including how to file and pay, see the Washington State DOR’s post.
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