Capital gains taxes are all over the news in recent days, but not all capital gains are taxed equally. To better understand capital gains tax, it is essential to consider the variables. If you have been following our recent blog postings, you may have noticed we have focused on providing clarity on Meme Stocks & the US Inflation Rate. As part of our Personal Financial Planning 101 series, this article will cover understanding capital gains tax.

 

What Are Capital Gains Taxes?

To better understand capital gains tax, it is essential to consider the financial implications when analyzing an investment’s performance. The tax implications can drastically affect the profit amount. These tax repercussions are known as capital gains. For example, when a stock is bought for $100 and sold for $150, there is a $50 gain taxed. This gain is “unrealized” while the stock is owned and does not become a taxable “realized” gain until the investment is sold. If funds are not withdrawn, taxes are still owed on profits that are “realized” within the account.

Calculating Capital Gains

 

Short-Term Vs. Long-Term Capital Gains Tax

The tax rate can vary dramatically between short-term and long-term gains. When a stock is held for less than one year, the gains are considered short-term. Meaning the gains will be taxed as ordinary income at tax time. For example, a $50 gain would be subject to what tax bracket you’re in. Furthermore, gains can be taxed up to a maximum of 37% in 2021! If a stock is held for more than one year. This gain is considered long-term and taxed at a preferential rate. The maximum long-term capital gains rate is 20% for high-income individuals/couples.  See below from Nerd Wallet for an overview of these preferential tax rates.

Capital Gains Demonstration Chart

Capital Gains Demonstration Chart continued

 

 

Calculating Your Capital Gains

When you file taxes, you only report the net gain or loss for the year. For example, if you make $50 on one stock but lose $100 on another, you have a net $50 loss. This loss will directly reduce your taxable income. However, only $3,000 worth of losses can be deducted in a single year. Any losses above $3,000 will be carried forward and can be applied to next year’s tax returns.

 

Summary: Capital Gains Tax 

In summary, understanding how to calculate your capital gains tax rate is an essential step for most investors. There are a few key factors to consider:

  • Capital gains tax is due when a profit is realized within an investment account. 
  • Short-term capital gains are derived when the investment is held for less than one year, and these gains are taxed as ordinary income.
  • Long-term capital gains are derived when the investment is held for more than one year and these gains are taxed at preferential rates.

Want to Learn More?

If you have any questions about taxes, your individual investment portfolio, our 401(k)-recommendation service, or anything else in general, please give our office a call at (586) 226-2100.  Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or overall financial situation, please contact the team at Summit Financial. We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.

 

Best Regards,

Zachary A. Bachner, CFP®

with contributions by Robert L. Wink, Kenneth R. Wink, and James D. Wink.