When it comes to long term investing, there are various aspects that can be hard for investors to track, such as the impact of market volatility, associated risks, taxes on returns, etc. A financial advisor can help you understand the financial implications of long term capital gains and help you gain a clearer understanding of the complicated tracking process.
Here is the financial advisor’s guide to long term capital gains:
What are long term capital gains?
Long term capital gains are gains that you earn on capital assets. These capital assets qualify as long term investments if they have been owned for at least 12 months from the date of their purchase and then sold for a profit or loss. An asset that is sold off before 12 months of its purchase is termed as a short term capital asset.
For instance, if you purchase a stock today and sell it at a 10% profit after 12 months or more, you earn a capital gain of 10% on your investment. On the other hand, if your investment shows a downfall trend, you suffer a long term capital loss. Either way, the profit or loss is termed as long term only if it has been held for a year or more.
What are long term capital gain taxes?
Taking the above example again, the 10% profit that you earn on your investment is not entirely your own. The government sees your profit as an income and taxes you on it. Long term capital gain taxes are charged on any earnings that you make on your long term investments. This is different from short term capital gains. In fact, long term capital gain taxes are lower than short term capital gain taxes. Hence, the time at which you sell your investment is crucial and makes all the difference.
How to report your long term capital gains for taxes
It is your, i.e. the investor’s, responsibility to report your long term capital gains to the Internal Revenue Services (IRS) using the IRS Form 8949. When you file your income tax return for a financial year, you are required to fill in the information of any gains that you have earned in that particular year. So, if you have earned a profit from an asset held for less than 12 months, the IRS will consider it as ordinary income and tax you as per the income tax slab you fall into. However, if you report a capital gain on an asset held for more than 12 months, the IRS will charge you a lower capital gains tax as per the total profit earned in the year. You can use the Schedule D of IRS Form 1040 to calculate your net capital gains.
How are long term capital gains taxed?
The Tax Cuts and Jobs Act in 2018 created a new and separate tax slab for long term capital gains in the country. These slabs differ for individuals, heads of households, individuals who are married but filing jointly and individuals who are married by filing separately. The tax rate ranges from 0% to 20% and can differ for each year. As per the latest long term capital gains tax rates, here’s how you are taxed:
- Single taxpayer:Â The lowest tax rate for a single taxpayer is 0% for up to $40,000. The highest tax rate is 20% for an amount of more than $441,450. A rate of 15% is charged for $40,001 to $441,450.
- Head of household:Â The lowest tax rate for a head of household is 0% for up to $53,600. The highest tax rate is 20% for an amount of more than $469,050. A rate of 15% is charged for $53,601 to $469,050.
- Married couple filing jointly:Â The lowest tax rate for a married couple filing jointly is up to $80,000. The highest tax rate is 20% for an amount of more than $496,600. A rate of 15% is charged for $80,001 to $496,600.
- Married couple filing separately:Â The lowest tax rate for a married couple filing separately is up to $40,000. The highest tax rate is 20% for an amount of more than $248,300. A rate of 15% is charged for $40,001 to $248,300.
In order to calculate your capital gains, you need to know your basis. The basis is the amount at which you purchase an asset. This includes any added fee or commission that you might have paid at the time. The next step is to calculate the realized amount or the price at which you sell the asset. You need to subtract the commission or fee (if any) paid while purchasing the asset from this amount.
If the realized price is more than the basis, then you have earned a capital gain. However, if the realized price is less than the basis, then you have suffered a capital loss on your investment.
What are the exceptions in long term capital gains while filing taxes?
If you have earned long term capital gains on any of the following assets, you need to pay a tax of 28%:
- Collectibles, such as coins, precious metals, stamps, etc.
- Musical instruments
- Vintage or old alcoholic beverages, such as wines
- Antiques and historical object
Apart from the above, investment gains made on tax-advantaged accounts such as the 401(k) retirement account, an individual retirement account (IRA), a 529 education savings account, etc. are not considered long term capital gains.
You can also qualify for an exception from capital gain tax in case of profits made from selling a home. However, you must be the owner of the house for at least two years and should have lived on the property for two years, and five years before you make the sale.
To sum it up
Long term capital gains can be a significant part of your wealth. But it is essential to know how they are taxed. This will allow you to sell your investments at the most appropriate time. Remember that tax rates for capital gains tend to change. So, it is good to discuss these modifications with your financial advisor.
You can get in touch with a professional Financial Advisor in your area and find out more about capital assets and investments. If you need any further clarifications or have any questions, visit Dash Investments or email me at dash@dashinvestments.com.