Uncle Sam wants his share of every dollar you earn. Not only do taxpayers have to claim their salary, but the IRS also taxes income earned from selling assets. You must report any profit earned from selling stocks, bonds, or even real estate. However, it's sometimes possible to reduce or offset capital gains to help lower your tax burden. Keep these points in mind come tax season:
1. The Buy-and-Hold Approach
People sell assets all the time, but it's usually better to wait before you sell. Short-term capital gains are assets sold for a profit less than a year after obtaining. However, if you hold an asset for over a year before selling, it becomes a long-term capital gain. The government gives preferential treatment to long-term capital gains. What does this mean? The longer you hold an asset before selling, the less the IRS will tax it.
Generally speaking, the government taxes short-term capital gains at the same rate as a person's regular tax income rate. Depending on a person's income, they could pay up to 37-percent on short-term capital gains. Long-term capital gains, on the other hand, are taxed at 15 or 20-percent. Even better, the IRS doesn't impose a capital gains tax on those making under a certain threshold.
2. Offset Gains with Losses
While some assets will appreciate in value, more than likely, other assets will lose money. Selling while an asset is down may not seem like an ideal situation, but it's possible to offset capital gains by taking advantage of capital losses. For instance, if you sell a stock for a profit of $2,000 but lose $1,500 on the sale of another asset, the IRS will only tax you on the difference. In this example, your taxable capital gains would be $500. Many investors sell long-term gains for a profit and use short-term losses to offset and reduce their taxes.
Savvy taxpayers can even use capital losses to offset their regular income. What's the benefit of doing this? If your tax return shows a loss, the IRS will not impose a capital gains tax. Furthermore, claiming enough short-term losses may even push you into a lower tax bracket.
3. Defer Losses Year-to-Year
Selling an ill-performing stock never feels good, but it could help you reduce capital gains down the road. The IRS allows taxpayers to carry forward any capital losses indefinitely. If the stock market rebounds the following year, a person can apply their previous losses to offset their capital gains tax. They may even use their losses during another tax year to help lower their taxable income. Selling at a loss isn't always a bad thing.
However, that doesn't mean you can buy and sell as you please. The government enforces the "wash sale" rule to prevent taxpayers from abusing this tactic. A wash sale happens whenever an investor sells an asset and immediately repurchases it within a 30-day window. Those who break this rule can't offset any gains with losses from these sales.
Take Advantage of Both Capital Gains and Losses
The capital gains tax often catches young investors by surprise. However, knowing how to properly manage your investment portfolio will ensure you never pay more than necessary. Using both gains and losses to your advantage may help reduce the amount you owe the IRS at the end of the year. Holding assets, offsetting gains, and deferring losses are just a few tactics you can consider as you fill out your annual tax returns.