Who has to pay the Washington state capital gains tax?

Tyler Kert
Tamarack Wealth Management

Tax season might be behind us, but it doesn’t mean it’s a good idea to stop tax-planning. Most people have heard about the Washington state capital gains tax but don’t actually know how it works. If you’ve heard bits and pieces and aren’t quite sure whether it affects you, here’s what you need to know.

Background

The Washington State capital gains tax went into effect on January 1, 2022, and applied for the first time to tax returns filed in 2023. It’s a 7% tax on the sale of long-term capital assets, such as stocks, bonds, and business interests. The tax is designed to target the state’s wealthiest residents and use the revenue to fund education and child services. But it isn’t just a tax on the ultra-rich. If you aren’t aware of how the tax works, you could be hit by an unexpected, and avoidable, additional tax on your capital gains. Let’s take a closer look at who can be impacted.

This 7% tax applies to long-term capital gains above the exclusion amount ($270,000 in 2024, adjusted annually for inflation). That means if you sell stock and realize $300,000 in gains, you’ll pay tax on $30,000 of that amount. Thankfully, this threshold is not based on your total income, just your net capital gains. If your salary is $250,000 and you have $50,000 in capital gains, you’re still under the exemption amount and won’t have to pay the tax. Now, individuals with significant real estate gains might be holding their breath, but thankfully Washington doesn’t tax every kind of gain. There are several exceptions.

What’s Exempt?

Among the gains that don’t count towards the Washington state capital gains tax are sales of real estate, retirement account distributions, depreciable property used in a business, and the sale of some family-owned small businesses. This is good news for real estate investors and retirees. So, for example, if you sell a rental property, you will have to pay federal capital gains tax, but you won’t be subject to this additional capital gains tax in Washington State.

Another question is whether investments in REITs (real estate investment trusts) or DSTs (Delaware Statutory Trusts) are exempt. These types of investments can be difficult to classify because they are ownership interests in real property, and yet at times can be traded like shares. The answer can be complicated. While the sale of real property is exempt, gains on REIT shares or DST interests may still be taxable depending on how they are structured and reported. If you find yourself in this situation, it’s worth digging into the details with your CPA or advisor.

Planning Ideas

No one likes to pay more tax than they need to, and there are legal ways to minimize exposure to this tax. The first way that you can minimize your tax liability is to be strategic in the timing of your sales. For example, if you have $500,000 of long-term capital gains built up in an account, don’t sell and recognize the entire gain in one year. Instead, take advantage of the annual exclusion amount and sell over multiple years to eliminate your tax liability. 

Tax-loss harvesting is another method that can allow you to avoid paying the capital gains tax. By offsetting long-term capital gains with long-term capital losses, you can reduce your tax liability or eliminate it altogether. It’s important to note, however, that you can’t offset long-term capital gains with short-term capital losses for the purposes of this tax. 

Furthermore, using tax-advantaged accounts, or donating appreciated assets to charity are additional ways to mitigate your tax liability. If you donate appreciated assets to charity, you can donate the full amount and won’t be subject to the 7% tax.

In conclusion, the Washington state capital gains tax won’t have an effect on most people. But, if you are selling appreciated stocks or business interests and are going to realize a significant gain, it’s worth reviewing your situation. Think you might be subject to the tax? Talk with your CPA or financial advisor before you sell appreciated assets. That one conversation could give you an idea to save you thousands and give you peace of mind.

This material is for informational purposes only and does not constitute financial, investment, or tax advice. Please consult your tax advisor or financial planner to discuss your specific circumstances before making any decisions.

Tyler Kert, a licensed financial advisor and CPA, provides financial planning and tax consulting services at Tamarack Wealth Management in Cashmere, WA.