The tax laws surrounding capital gains taxes are more complicated than people think. How much you will own in capital gains taxes will depend on what you are selling, how long you have held it, as well as your overall income. As we approach year’s end, it is an excellent time to have a refresher on what you need to know about capital gains taxes.
For those in the lowest income-tax brackets, capital gains are not much of an issue. In reality, the lower your income, the less likely you are to own substantial amounts of assets that could be sold with taxable gains. Even if you do, many of those investment gains will be taxed at a zero percent capital gains rate.
Those in higher income-tax brackets may find calculated their capital gains taxes much more complicated. You may find yourself paying higher capital gains rates at higher levels of income. Likewise, there is also a 3.8% surtax on higher-income earners to help fund the Affordable Care Act (aka Obamacare). I should also mention capital gains taxation can vary at the state level as well.
Here is some information on the tax brackets for capital gains in 2020. I will say owing a ton in capital gains can be a good thing; it means you have made money on your investments. That being said, proactive tax planning with the help of a fantastic fiduciary financial planner can help minimize your capital gains taxes each year without sacrificing portfolio growth.
Who Qualifies for The Zero-Percent Capital Gains Rate?
For 2020, the zero rates apply to most singles with a taxable income of up to $40,000 and married couples, filing jointly, with a taxable income of up to $80,000. This means the average worker in the United States would fall into the zero-percent capital gains tax bracket.
The next capital gains tax bracket comes with a 15% rate. This rate applies to most singles earning up to $441,450 and joint filers up to $496,600. Earn more than this, and you’ll find yourself in the top capital gains tax bracket of 20%.
What About The 3.8% Medicare Surtax?
Unfortunately, the taxes on investment income does not end at the aforementioned capital gains taxes. I would be remiss if I didn’t mention the 3.8% surtax on “net investment income” for joint filers with modified adjusted gross income of more than $250,000 and most singles above $200,000. This surtax will hit in both the 15% and 20% capital gains tax brackets. For those in the 20% capital gains tax bracket, that effectively raises your top rate to 23.8%. These top rates make things like tax-loss harvesting imperative for those benefitting from strong investment results.
Not All Capital Gains Are Created Equal
Depending on what you are selling, you may find your capital gains taxes differ from what has been mentioned so far in this article. For example, there is a 28% maximum tax on gains when selling art and collectibles. There are also specific tax rates for some depreciable real estate or some types of small business stocks.
You are likely aware of special rules when you sell your primary residence. In short, those who follow IRS rules will owe no taxes on the first $250,000 of real estate gain if they file single, or $500,000 if married, filing jointly. Consult your tax advisor or Certified Financial Planner for specific rules to qualify for this valuable tax break.
Long-Term Capital Gains Versus Short-Term Capital Gains
How long you have held an investment can dramatically change the taxation of gains. Short-term capital gains rates apply to investments held for less than a year. These gains will be subject to ordinary income-tax brackets, which can be as high as 37%, in 2020.
Generally speaking, investments held for at least one year will qualify for long-term capital gains rates. At this time, long-term capital gains rates are lower than ordinary income tax brackets. So, with tax planning in mind, ideally, you would not realize investment gains until they qualify for long-term capital gains rates.
Tax-Loss Harvesting to Low Investment Taxation
Simply put, tax-loss harvesting is the act of selling investments to minimize the taxes on your overall investment portfolio. Tax-loss harvesting is more about taxation than investing. You can harvest both short-term losses as well as long-term losses. Depending on your situation, one may be much more valuable than the other.
When we are tax-loss harvesting, we are selling certain shares of an investment at a loss to reduce taxes on the investment portfolio at the end of the year. You can use up to $3,000 of short-term losses to offset regular income. This number is the same whether you are filing as single or married, filing jointly. If you are selling an investment with long-term capital losses, you can use these losses to help offset the capital gains from other investments that have been sold for a profit. Tax-loss harvesting before year’s end can help you pay fewer taxes in 2020.
Understanding the drag that taxes can have on your long-term investment returns can help you make smarter financial choices over time. These smarter choices can help make achieving financial independence and building wealth easier. If nothing else, understating the rules around capital gains can avoid a big tax surprise when filing your taxes. Work with a fiduciary financial planner to develop a roadmap to reaching your various financial goals while minimizing taxes along the way.
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