Capital Gains: Beyond The Buy And Hold

• However, items held primarily for sale to customers in the ordinary course of business (like inventory) are not considered capital assets.

Short-Term vs. Long-Term Capital Gains

The length of time you hold an asset before selling it significantly impacts the tax rate applied to your capital gain.

• Short-term capital gains: Profits from assets held for one year or less are taxed at your ordinary income tax rate, which can be significantly higher.
• Long-term capital gains: Profits from assets held for more than one year are taxed at preferential rates, which are generally lower than ordinary income tax rates. These rates depend on your taxable income and filing status. The long-term capital gains rates are typically 0%, 15%, or 20%. A higher rate of 28% can apply to certain collectibles and small business stock.

Example of Calculating Capital Gains

Let’s say you bought 100 shares of a company’s stock for $50 per share, totaling $5,000 (excluding commissions). After holding the stock for two years, you sell those 100 shares for $80 per share, totaling $8,000 (excluding commissions).

• Purchase Price (Cost Basis): $5,000
• Selling Price: $8,000
• Capital Gain: $8,000 – $5,000 = $3,000

Because you held the stock for more than one year, this is a long-term capital gain and taxed at either 0%, 15%, or 20%, depending on your income bracket.

Capital Gains Tax Rates

Understanding the applicable tax rates is essential for effective tax planning. As previously mentioned, short-term capital gains are taxed at your ordinary income tax rate. Long-term capital gains rates are dependent on your taxable income.

Long-Term Capital Gains Tax Brackets

As of 2024, the long-term capital gains tax rates are generally as follows:

• 0%: Applies to taxpayers in the lower income tax brackets.
• 15%: Applies to most taxpayers who are not in the 0% or 20% brackets.
• 20%: Applies to taxpayers with higher incomes.

You should consult the IRS guidelines or a tax professional for the most up-to-date and accurate information regarding income thresholds.

Net Investment Income Tax (NIIT)

High-income taxpayers should also be aware of the Net Investment Income Tax (NIIT).

• The NIIT is a 3.8% tax on the lesser of your net investment income or the amount by which your modified adjusted gross income (MAGI) exceeds certain thresholds.
• Investment income includes capital gains, dividends, interest, rental and royalty income, and passive activity income.

Strategies for Minimizing Capital Gains Taxes

There are several legal strategies you can use to minimize your capital gains tax liability. These involve careful planning and consideration of your overall financial situation.

Tax-Loss Harvesting

• What it is: Selling investments that have lost value to offset capital gains. You can use capital losses to offset capital gains dollar for dollar. If your capital losses exceed your capital gains, you can deduct up to $3,000 of the excess loss against your ordinary income (or $1,500 if married filing separately). Any remaining unused capital losses can be carried forward to future tax years.

• Example: You have a $5,000 capital gain from selling stock A. You also have a $2,000 loss from selling stock B. You can use the $2,000 loss to offset the $5,000 gain, reducing your taxable capital gain to $3,000.

Holding Assets for Longer Than One Year

• As previously noted, holding assets for more than one year allows the gains to be taxed at the lower long-term capital gains rates. This can result in significant tax savings compared to selling assets held for a shorter period.

Investing in Tax-Advantaged Accounts

• Retirement Accounts: Contribute to tax-advantaged retirement accounts like 401(k)s, IRAs (Traditional and Roth), and HSAs. Gains within these accounts are either tax-deferred (Traditional 401(k) and IRA) or tax-free (Roth 401(k) and IRA) while in the account.

Gifting Appreciated Assets

• Gifting: Consider gifting appreciated assets to family members in lower tax brackets. This can shift the tax burden to someone who will pay a lower capital gains tax rate when they eventually sell the asset. Note: gift tax rules apply.

Qualified Opportunity Zones (QOZs)

• QOZs: Investing in Qualified Opportunity Zones can offer tax benefits, including deferral or elimination of capital gains taxes if certain requirements are met. This is a complex area and requires careful consideration and consultation with a financial advisor.

Capital Gains and Real Estate

Real estate transactions often involve significant capital gains, making it crucial to understand the tax implications.

Selling Your Primary Residence

• Exclusion: Under certain conditions, homeowners can exclude up to $250,000 of capital gains ($500,000 for married couples filing jointly) from the sale of their primary residence. To qualify, you must have owned and lived in the home for at least two out of the five years preceding the sale.

Investment Properties

• Capital Gains: The sale of investment properties (rental properties) is subject to capital gains taxes. Depreciation taken during the ownership period may also be subject to depreciation recapture, which is taxed at your ordinary income tax rate up to a maximum of 25%.
• 1031 Exchange: A 1031 exchange allows you to defer capital gains taxes when selling an investment property and reinvesting the proceeds into a “like-kind” property. This is a complex transaction that requires careful planning and adherence to strict IRS rules.

Example: Real Estate Capital Gains

You purchased a rental property for $200,000. Over the years, you took $40,000 in depreciation deductions. You sell the property for $300,000.

• Adjusted Basis: $200,000 (purchase price) – $40,000 (depreciation) = $160,000
• Capital Gain: $300,000 (selling price) – $160,000 (adjusted basis) = $140,000
• The $40,000 in depreciation is subject to depreciation recapture, taxed at a maximum rate of 25%. The remaining $100,000 is taxed at your long-term capital gains rate.

Cryptocurrency and Capital Gains

The IRS treats cryptocurrency as property, meaning the sale or exchange of cryptocurrency can result in capital gains or losses.

Reporting Cryptocurrency Transactions

• Track Transactions: It is essential to keep accurate records of all your cryptocurrency transactions, including the date of purchase, the purchase price, the date of sale, and the sale price.
• Tax Forms: Use IRS Form 8949 to report capital gains and losses from cryptocurrency transactions.

Wash Sale Rule