Investing in assets like stocks, bonds, or real estate can be a great way to build wealth. However, it’s essential to understand the concepts of capital gains and capital losses, as they play a crucial role in your investment strategy and tax planning.
What are capital gains?
Capital gains occur when you sell an asset for more than you paid for it. The gain is the difference between the selling price and the purchase price. For example, if you bought a stock for $1,000 and sold it for $1,500, your capital gain would be $500. There are two types of capital gains:
Short-term capital gains
These are gains on assets held for one year or less. They are typically taxed at your ordinary income tax rate.
Long-term capital gains
These are gains on assets held for more than one year. They benefit from lower tax rates, which can be 0%, 15%, or 20%, depending on your income level.
A Medicare surtax of 3.8% may also be imposed on interest, dividends, capital gains, and other investment income for those individuals making more than $200,000 ($250,000 if married filing jointly or 125,000 if married filing separately). These amounts are not indexed for inflation for individuals and have been the same since they were introduced to fund Medicare expansion through the Affordable Care Act of 2010.
What are capital losses?
Capital losses occur when you sell an asset for less than you paid for it. The loss is the difference between the purchase price and the selling price. For instance, if you bought a stock for $1,000 and sold it for $800, your capital loss would be $200.
Why do capital gains and losses matter?
Understanding capital gains and losses is important for several reasons:
Tax Implications
Capital gains are subject to taxes, but the rate depends on whether the gain is short-term or long-term. Conversely, capital losses can offset capital gains, reducing your taxable income. If your losses exceed your gains, you can use up to $3,000 of the excess loss to offset other income, with the
remainder carried forward to future years.
Investment Strategy
Knowing how gains and losses affect your taxes can help you make more informed investment decisions. For example, you might choose to hold onto an asset for more than a year to benefit from lower long-term capital gains tax rates.
Portfolio Management
Regularly reviewing your portfolio and understanding your gains and losses can help you manage risk and optimize returns.
Tips for managing capital gains and losses
1. Keep Good Records: Maintain detailed records of your asset purchases and sales, including dates and prices. This information is crucial for accurately calculating your gains and losses. This has been made much easier in today’s age of digitization.
2. Consider Tax-Loss Harvesting: This strategy involves selling losing investments to offset gains from the sale of winning investments, thereby reducing your overall tax liability.
3. Plan Your Sales: Be mindful of the holding period of your investments. Selling after one year can significantly reduce your tax burden due to the lower long-term capital gains tax rates.
4. Consult a Tax Professional: Tax laws can be complex and change frequently. A tax professional can provide personalized advice and help you navigate the intricacies of capital gains and losses.
It is fair to say that most people don’t enjoy paying taxes, especially on an amount earned from your excellent investment knowledge and acumen. It is certainly not popular news to deliver to clients that they will owe taxes. However, one thing to keep in mind is that if you incur capital gains tax, it means you made money. The gain has been locked in from selling that investment.
Capital gains are top of mind when rebalancing our clients’ taxable accounts. We look for opportunities in years of temporarily low or reduced income to sell appreciated assets and capture a lower capital gains rate. On the same token, we look for tax-loss harvesting opportunities to offset gains when the market is down.
Questions about capital gains and losses and what Heartland Trust Company can do for you? Give us a call and we will gladly sit down with you to answer them.
This is not intended to be tax or investment advice. Everyone’s tax and financial circumstances are unique. We advise you to consult with a tax professional for further assistance with your tax situation. If you have questions on your personal
investments, please reach out to your investment professional.
