Is This Your Situation: Trying to Figure Out Capital Gains

A capital gain occurs when you sell an investment for more than you spent to acquire it. For example, if you bought stock for $3,000 and sell it for $5,000, you have realized a capital gain of $2,000. That gain is taxable, and you are required to report it to the Internal Revenue Service. That is just the basic concept. Capital gains taxes have several fine points.

Short-Term Gains

The system is designed to encourage long-term investing, so the tax bite from short-term gains is significantly larger than that from long-term gains. If you sell an asset that's appreciated that you've owned for a year or less, it's a short-term capital gain and you'll pay a higher capital gains tax rate on such investments, often 10 to 20 percent more, and sometimes even higher.

Long-Term Gains

If you sell an investment asset after owning it for more than a year, any gain you have is a long-term capital gain. That difference in tax treatment is one of the advantages a buy-and-hold investment strategy has over one that involves frequent buying and selling, such as in day trading.

You can anesthetize your tax hit: Because investments don't always go up in value, if you sell something for less than what you paid for it, you have a capital loss. Capital losses from investments can be used to offset capital gains. So, for example, if you have $50,000 in long-term gains from the sale of one stock but $20,000 in long-term losses from the sale of another, you could be taxed on only $30,000 worth of long-term capital gains.

If capital losses exceed capital gains, you may be able to use the loss to offset up to $3,000 of other income. If you have more than $3,000 in capital losses, the excess can be carried forward to future years to offset income in those years.

Tax Brackets

Also consider tax brackets: The amount an investor is taxed depends on his or her tax rate.

People in the lowest tax brackets usually don't have to pay any tax on long-term capital gains. The difference between short- and long-term gains, then, can be the difference between having to pay taxes or no taxes at all.

Short-term capital gains are taxed at the investor's ordinary income tax rate. Long-term capital gains are taxed at 15 percent for individuals in the lowest two income tax brackets, whereas a 20 percent rate applies to those in the 39.6 percent tax bracket. Because these amounts can change over time, you have to check the most recent rules.

Capital gains are complex, and it is essential to understand your situation before you sell a security. Give us a call, and we'll help you plan for the taxes you have to pay and advise you on the most tax-efficient ways to manage your portfolio.

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