Understanding how capital gains and losses work

Buying an investment and selling it at a profit is a path many choose to grow their wealth. However, when you sell an investment for a profit, you owe taxes on the profit. Additionally, there is no guarantee that you will be able to sell for a profit, which means you might have to sell for a loss. But do not worry. There is a strategy for selling gains and losses that can help you get the most out of your circumstances.

Your investments include any financial assets you hold, including stocks, bonds, mutual fund shares and real estate. As to your primary residence, however, once every two years, the first $250,000 of gain if single and $500,000 if married is nontaxable. Above these limits, a capital gains tax is assessed. When you sell any investment for more than you paid for it, the result is referred to as a capital gain. If you sell at a loss, the result is known as a capital loss.

How are capital gains taxed?

How your capital gains are taxed depends on whether they are classified as short-term or long-term:

• Short-term capital — Short-term gains includes any asset you have owned for one year or less. Short-term capital gains are taxed at your maximum tax rate. For those in a lower bracket, it is not very painful, but for those at the top tax rate of 37%, it can be significant especially compared to the long-term rate for capital gains.
  
• Long-term capital — Long-term capital gains occur on any capital asset you have owned for more than one year. Taxes on long-term rates are either 0%, 15% or 20% depending on your tax bracket and your filing status.

The holding period on your investments is defined by how long you own the asset before you sell it. The holding period does not include the day you purchased the asset, but it does include the day you sell it. So, if you purchase property on October 5, 2020, your holding period begins on October 6, 2020. If you sell this property before October 6, 2021, it will be classified as short-term. If you sell on the 6th or afterward, your capital will be classified as long-term. 

Determining when to sell an asset depends on what you stand to profit and how you will be taxed when making the sale. For example, you may stand to generate a large profit off a short-term gain, but the higher tax rate may offset the benefits of the large sale. Or, the profit may be large enough to make the cost of a higher tax rate worth it.

We suggest using this capital gains tax calculator from SmartAsset to help you determine the value of your capital gains and what you can expect to pay in taxes when making a short-term or long-term sale.

What about selling at a loss?

Unfortunately, not every investment works out the way you want it to. You may have purchased stock with the intent of selling it for a gain, but the value keeps dropping as the days go by. At the end of the year, you are liable for taxes on your assets if you sell during the year. However, if an asset is not performing well, you can sell it at a loss and claim capital loss deductions.

No one intends to lose money on an investment, but declaring a capital loss can help you lower your tax liability for the given year by offsetting any capital gains and up to $3,000 of ordinary income, which can ultimately work to help you get the most out of the situation. 

Talk to a ProVise CFP® professional about managing your personal finances and investments

Deciding on when to sell investments can be tricky for investors, especially in a volatile and unpredictable market. Selling without a plan would be like driving while blindfolded. You need the help of a financial advisor to remove the blindfold and provide a path for helping you reach your financial goals.

At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.

Are you ready to talk to a professional about managing your personal finances? Contact ProVise today to schedule a complimentary consultation.