Here’s How To Understand Short-Term Vs. Long-Term Capital Gains
Capital gains are the profit you make from selling a capital asset for more than its original cost. Collectables, real estate, stocks, and bonds are all capital assets. The length of ownership time before the sale of an asset determines the tax amount due. The IRS classifies the time lengths as short-term—holding the asset for less than a year—and long-term—holding it for over a year.
The ease of trading online has increased investment buying and selling. Investors holding assets for under a year should be mindful of applicable higher tax rates. The federal taxes on short-term capital gains and dividends are the same as ordinary and earned income, up to 37% based on the investor’s tax bracket. (Exceptions apply if these gains push the seller into a higher tax bracket.)
Investments held longer than a year before being sold incur long-term capital gains. When capital losses occur in the same year, they can offset the taxable amount. The amount taxed is the net capital gain—the total gains minus losses as a positive amount.
So if an investor sold assets for a $6,000 loss and other assets for an $11,000 gain, the $5,000 positive difference is the taxable amount. The 2020 federal tax rates for long-term net capital gains were 0%, 15%, or 20%, depending on the seller’s tax bracket and filing status.
Any excess capital loss carries over to the following year’s taxes. However, a wash-sale happens when the investor sells and rebuys investments (or “substantially identical” securities or stocks) within a 30-day window. Wash-sale losses are not deductible to prevent the artificial inflation of losses.
Investors with capital gains may also owe state-level taxes. Some other states—Colorado, Nevada, and New Mexico—have no capital gains taxes. Other states treat capital gains favorably, like Montana’s offset credit.
States that lack an income tax will also lack a capital gains tax because capital gains are officially considered income. These states are Alaska, Florida, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Investors who pay capital gains lose part of their investment profit. There are legitimate ways to avoid paying capital gains or at least offsetting them to lower amounts. The easiest way is to hold on to investments for over a year, making it a long-term rather than a short-term.
Another way is to keep good records and offset capital gains with capital losses. Excess profits up to $3k are claimable against income, or investors can rollover the excess against future liability. Investors should be mindful to avoid wash-sales.
Finally, procuring a good financial advisor, tax accountant, or reputable tax software is a positive step to finding legal avenues investors might miss.
Long-term capital gains taxes are lower than short-term. Investors, therefore, pay fewer taxes by holding assets over a year. There are strategies to lower the taxes due. Investors should seek professional assistance to avoid missing essential tax