3 Things to Help Determine if Capital Gains Tax Applies to You
Hello and welcome to Radiant Wealth Planning, a virtual financial planning and investment management firm exclusively for women. I’m Randa Hoffman, owner, and financial planner, and I’m located in sunny Newport Beach, California.
Today’s blog will answer the question will you have to pay taxes on the sale of your investments. We need to start by knowing 3 things: First, what type of account the investments are in, second, the price you bought and sold it at, and third, how long you’ve owned it.
Types of accounts
Accounts fall into three tax treatments, which can either be taxable, tax-deferred, or tax-free. A taxable account is when you pay the taxes at the end of the year, an example of this is a savings account, or a brokerage account. A tax-deferred account is when the taxes are deferred until you take the money out, think of your 401(k) or a traditional IRA. Even if you change the investments in the account, you won’t pay taxes until you take a distribution. The third type is tax-free, an example is a Roth IRA. When the money is in a Roth, you don’t pay any taxes even when you sell an investment, and when the money is taken out you don’t pay taxes.
Now we know that it is taxable accounts that will have taxes when you sell an investment because it’s not a tax-deferred or tax-free account.
Capital Gain or Capital Loss
The second part and is knowing if you had a gain or loss, and to calculate that we need to know the investment’s basis and what you sold it at. The basis is how much you paid for an investment including fees, like a commission. When you subtract the basis and the sale price, you’ll know if you’ve made money or lost money on the investment.
For example, you bought a stock for $20 and there was a commission of $1, the basis is $21. If you sold it for $19 because that was the value at the time, you end up with a loss of $2, that’s called a Capital Loss. But if you sold it for $25, you end up with a gain of $4, that’s called a Capital Gain.
Long-term or Short-term Capital Gain
Now that we know we have a capital gain; the third step is determining if it’s a long-term capital gain or a short-term capital gain; each one has taxed differently. It’s considered short-term if you’ve owned the investment for one year or less, and if you owned it for more than 1 year, then it’s long-term.
The short-term capital gain tax rate is based on your income tax bracket. Long-term capital gain gets favorable tax treatment, meaning it’s taxed at a rate that is lower than short-term capital gain. You get a benefit for holding the investment for more than a year.
There are 3 possible tax outcomes for long-term capital gain and that will be determined based on your taxable income. Taxable income is earned income plus investment income. The 3 possible tax rate outcomes are: you don’t pay any taxes, you pay 15%, or you pay 20%.
There are a few important things I need to mention: First, a capital loss can possibly offset a capital gain. Second, when you sell an investment keep in mind that there could be other taxes like Alternative Minimum Tax (AMT) or Net Investment Income Tax (NIIT). Third, selling investments could increase other taxes like Social Security.
Welcome to our blog where we share tips and advice on all topics that help women meet their financial goals.
About the Author
Randa Hoffman is the owner and financial planner at Radiant Wealth Planning, a fee-only financial planning and investment management firm exclusively for women. She helps ease the uncertainty around retirement, tax planning, and transitioning wealth so that women can live a life they’ve always dreamt of. She holds an MBA and EA and lives in Newport Beach, CA.
