The Savvy Investor’s Guide to the Capital Gains Tax

The Savvy Investor’s Guide to the Capital Gains Tax

Chris Thompson, CEPF®   Fri, February 11, 2022, 11:19 AM·11 min read

If you make money from just about any source, you’re likely to find Uncle Sam nearby. It’s true of money you earn from a job, and it’s true of money you earn from investments – whether that’s stocks, real estate or collectibles. Any profit you earn from selling an investment is known as a capital gain, and the tax on this form of income is called the capital gains tax. Depending on how long you’ve held the asset before selling it, you’ll be taxed at either the short-term or long-term capital gains rate. In this article we’ll explain how the capital gains tax works, the difference between long- and short-term capital gains, the rates you’ll pay on the federal and state levels, and how to minimize the tax impact on your investments.

A financial advisor can help you tax-optimize your investment portfolio.

What Are Capital Gains, and How Are They Taxed?

When you buy an investment asset, you’re hoping that it will appreciate in value, thereby giving you the option to sell it for more than you initially paid for it. If you do, these profits are referred to as “capital gains” by the government.

For example, let’s say you buy 10 stocks in a company at $12, then later sell them at $15 a share. In this case, you have capital gains of $30.

Of course, you won’t always be so lucky. Let’s say another investment doesn’t do as well, and you sell it for less than what you originally paid for it. This is referred to as a capital loss.

At the end of the year, you tally up your capital gains and losses; if you’ve had a good year and your gains exceed your losses, then you deduct your losses from your gains to find your net capital gains.

These gains constitute income, so the federal government (as well as some state governments) will tax them. This is known as the capital gains tax.

Capital Gains Tax Rates: Short-Term vs. Long-Term

The timeline on which you purchase and sell your assets comes into play for capital gains taxes. The government splits capital gains into two categories: short-term and long-term. For investment profits to be considered “long-term,” the asset must be held by the owner for at least one year before sale. Any profits from the sale of assets held for less time than that are considered “short-term” capital gains.

Short-term capital gains are taxed at ordinary income tax rates. This can become problematic for those with a high income, as federal income tax rates can reach as high as 37%. And that doesn’t even account for state taxes.

Long-term capital gains, on the other hand, receive special tax treatment if you reach that one-year threshold. The top federal long-term capital gains rate is 20%, which is lower than all but two of the seven ordinary income tax rates. The other long-term capital gains tax rates are 0% and 15%.

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https://news.yahoo.com/savvy-investor-guide-capital-gains-161914828.html