Understanding Capital Gains Taxes When You Sell Investments
Market downturns, like the one we’re currently experiencing this year, could be a good time to adjust your investment portfolio to minimize the tax bite. Here’s how it works.
Investments in taxable accounts held longer than one year are taxed as a long-term capital gain. The rates are either 0%, 15% or 20%, depending on your income.
Source: Internal Revenue Service
If held less than a year, then the sale is a considered a short-term capital gain and taxed as ordinary income based on your marginal tax bracket.
When calculating net capital gains taxes, you should first evaluate all short-term and long-term transactions separately:
1. Sum all long-term gains and subtract all long-term capital losses.
2. Then sum all short-term gains and subtract all short-term capital losses.
If both long-term and short-term capital gains are positive, evaluate each separately against relevant tax rates.
If both long-term and short-term capital gains are negative, your capital gains tax is zero.
If the sum of total your long-term and short-term gains is zero, your capital gains tax is zero.
If one of your long-term or short-term gains is positive while the other is negative, subtract the negative from the positive. Next, evaluate the capital gains tax on the remaining amount.
For example, if your long-term gains are $15,000, and your short-term losses are -$5000, you should subtract the loss from the long-term profit. Then, you can calculate the long-term capital gains tax on the remaining $10,000.
Trimming Taxes
If your losses exceed gains, you can use the excess to reduce your ordinary income up to $3,000 per year ($1,500 for individuals and married filing separately), carrying over any remaining losses to future years.
Let’s say you have two taxable investments (A and B), each with a cost basis (what you paid for the fund originally) of $15,000.
Fund A’s current value is $17,000 and when sold has a $2,000 long-term gain.
Fund B’s current value is $11,000 and when sold has a $4,000 long-term loss.
$2,000 - $4,000 = 2,000. Therefore you would have a $2000 net loss.
These strategies become even more important with larger holdings and if you have funds that rebound in value in the future.
Social Security and Other Tax Issues
Be careful with your capital gains. For instance, a gain taxed at even the 0% rate can increase your adjusted gross income, in turn possibly increasing taxes on your Social Security income.
Also, use care after you sell a holding that recognized a loss. The “wash-sale” rule prohibits selling an investment for a loss and replacing it with the same or a "substantially identical" investment 30 days before or after the sale. If you have a wash sale, the IRS will not allow you to deduct the loss for the current tax year, which could make your taxes for the year higher than you hoped.
Weiser Financial Planning LLC does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
