Hold onto your hats, y'all — we're about to discuss long-term versus short-term capital gains from investing, which we all know is a wild topic.
In the world of investing, gains are the name of the game. You invest your money in the stock market hoping that it will gain enough that by the time you take it out in retirement, you've got enough money to support yourself and your family.
But what are the details when it comes to those gains? Are they entirely yours? Do taxes play a part in this system?
Long story short: It's not as simple as dropping money into the stock market and then taking it out again. There are tax laws that play into your stock market earnings. And that's what we'll cover today.
What Are Capital Gains?
Simply put, capital gains are money earned from the sale of a capital asset. The definition of “capital asset” can mean property, such as your home or a rental home, or it can be your stock portfolio. (Actually, the IRS recognizes almost everything — including things like cars and boats — as capital assets.)
For our purposes, we're going to focus on stocks and investments as capital assets.
Tax on capital gains is different from tax on dividends earned from investing. Capital gains taxes come with their own rules. And those rules depend on how long you've owned the asset. That's why we have two terms to describe them: short-term and long-term capital gains.
What Are Short-Term Capital Gain Taxes?
Short-term capital gains are any profits you make off the sale of an asset that you owned for one year or less. If you bought stock on July 1, 2018, and sold it for a $300 profit on March 29, 2019, that's considered a short-term capital gain. The year starts the day after you purchase stock.
Short-term capital gains are taxed at the same rate as your ordinary income. Those tax rates range from 10% to 37%. Your total taxable income amount determines which bracket you're in.
What Are Long-Term Capital Gain Taxes?
And then are long-term capital gains. These are any profits you make off the sale of assets you've owned for longer than a year. These are not taxed at the same rate as your ordinary income. And that can mean a lot of savings.
There are only three brackets for capital gains income: 0%, 15% and 20%. What this means is you'll have your ordinary tax bracket for the money you earn from your day-to-day job. And you'll have one of these three brackets for the money you earn selling your long-term capital assets.
Here's a look at the new income brackets for long-term capital gains in 2019.
|Tax Rate||Single||Married Filing Jointly||Heads of Households|
|0%||$0 to $39,375||$0 to $78,750||$0 to $52,750|
|15%||$39,376 to $434,550||$78,751 to $488,850||$52,751 to $461,700|
|20%||$434,551 or more||$488,851 or more||$461,701 or more|
If you're single and take a profit of more than $39,375 selling stocks, you're in the 15% capital gains tax bracket.
Right away, you've probably noticed that even the highest tax bracket for your capital gains income is 17% less than the highest tax bracket for earned income. This difference in tax rates is a huge benefit to those who make money selling stocks.
What About Capital Losses?
Since no stock will ever provide endless profit, there are also laws that explain how to handle capital losses.
The IRS lets you use your “net” capital loss to reduce your tax burden. Take your gains, subtract your losses, and if you end up with a net loss, you can deduct up to $3,000 annually to reduce your taxable income. (Or $1,500 if you're married and filing taxes separately.) Not only that, but additional losses can be carried into the next year to continue to offset capital gains and $3,000 of ordinary taxable income.
How to Save on Capital Gain Tax
As you see, there's a difference between your ordinary income tax rate and your capital gains tax rate. So, there's a huge opportunity for tax savings. Here's what you can do:
- Don't sell in the short term.
As with most investing advice, try to get in it for the long term. Selling your short-term capital assets means you'll be taxed at your regular income rate. No savings to be found there!
- Stick around when it comes to property.
Buying a house can be a great investment. Living in that house for at least two years in a five-year period qualifies you to exclude up to $250,000 of capital gains from the sale of that house. (To qualify, you can't have already excluded another home from your taxes in the two years before the sale.) The exclusion goes up to $500,000 if you're married and filing jointly.
- Utilize your retirement accounts.
You don't have to pay taxes on sales done within tax-free accounts, such as your Roth IRA. In tax-deferred accounts, such as your 401(k), you won't pay income tax on the amount you earn and place into the tax-deferred account, nor on the amount earned within the account, but you will pay tax on the amount you withdraw in retirement.
- Pay attention to your losses.
Being able to carry your losses through to future years means you can reap tax benefits for years to come. Keep a close eye on your losses, and keep good financial records for yourself.
You can also use the following recommended tax services:
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|TaxAct Premier+||Easiest for Investors|
|H&R Block Deluxe||Unlimited Real-Time Tax Advice|
|eSmart Tax Deluxe||Tailor-Made for Investors|
|TaxSlayer Premium||All Needed Tax Breaks for Investments|
|Liberty Tax||Fast, Easy and Secure Online Tax Filing|
Your Plan Is Unique to You
As with all personal finance advice, what makes the most sense when it comes to capital gains is going to depend on who you are and what your money goals are.
Especially when it comes to taxes. Consult your accountant or tax advisor before you make any radical decisions. Being self-educated is great, but the Tax Code is notoriously dense. So it's always best to consult a professional.