Capital gains are the profits realized from the sale of capital assets such as stocks, bonds, and property. The capital gains tax is triggered only when an asset is sold, not while the asset is held by an investor. However, mutual fund investors could be charged capital gains on investments in the fund that are sold by the fund during the year.
There are two types of capital gains: long term and short term; each is subject to different tax rates. Long-term gains are profits on assets held longer than 12 months before they are sold. Long-term capital gains are generally taxed at special capital gains tax rates of 0%, 15%, and 20% depending on your taxable income. Short-term gains (on assets held for 12 months or less) are taxed as ordinary income at the seller’s marginal income tax rate. You may be subject to an additional 3.8% Medicare unearned income tax on net investment income (unearned income includes capital gains) if your adjusted gross income exceeds $200,000 (single filers) or $250,000 (married joint filers).
The taxable amount of each gain is generally determined by a “cost basis” — in other words, the original purchase price adjusted for additional improvements or investments, taxes paid on dividends, certain fees, and any depreciation of the assets. (If you received the property by gift or inheritance, different rules apply to determine your starting basis.) In addition, any capital losses incurred in the current tax year or previous years can be used to offset taxes on current-year capital gains. Losses of up to $3,000 a year may be claimed as a tax deduction.
Long-Term Capital Gains
To avoid the highest capital gains tax, examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate as high as 40.8 percent with long-term losses (up to 23.8 percent). In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.
The lowest tax rate for long-term capital gains is 0% which applies when your taxable income is less than $80,000 (Married Filing Jointly) or $40,000 (Single). Note that state taxes may still be applicable on your long-term capital gains even if the 0% Federal tax rate applies.
Loss Harvesting
Loss harvesting refers to selling part of your portfolio of stock at a loss to offset realized gains. However, you should be mindful to avoid the wash-sale loss rule. Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before the date of sale or after the date of sale, you don’t recognize your loss on that sale. Instead, you are required to add the loss amount to the basis of your new stock.
Stock Gifts
If you give money to your parents to assist them with their retirement or living expenses or provide for children (specifically, children not subject to the kiddie tax) a stock gift may be advisable. Consider giving appreciated stock to your parents and your non-kiddie-tax children if they are in lower tax brackets than you are.
Donation of Stock
If you are going to make a donation to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit. You deduct the fair market value of the stock as a charitable donation. You don’t pay any of the taxes you would have had to pay if you sold the stock.
