Capital gains taxes are taxes you can claim on the profits you realize from selling your property, your investments or commodities. If you are holding stocks and you realize a profit by selling them in the stock market, you should report the capital gains to your tax report. The same goes if you realize a profit from selling your house for a profit. Put simply any capital asset you sell and you gain a profit, you are obliged to report it in your tax report.
How Are Capital Gains Taxed?
Generally, the Internal Revenue Service (IRS) imposes a tax on the net capital gains. However, there are IRS preferential tax rates that aim to provide incentives to investors to make more investments, but also to encourage entrepreneurial activity.
In fact, short-term capital gains and long-term capital gains are not taxed in the same way. Short-term capital gains are on investments you hold for a year or less before selling them and are viewed as ordinary income. Therefore, if you receive $70,000 as a total taxable income and $10,000 from short-term investments, your total taxable income is $80,000, and you fall under the 25% taxable bracket, according to the 2016 taxable brackets. Conversely, long-term capital gains are on investments you hold for more than a year before selling them. The IRS imposes a lower tax, typically a flat 15-20% rate, on long-term capital gains to encourage long-term investing and entrepreneurial activity.
How Can You Lower Your Tax Rate Using Your Capital Gains?
- Choose long-term investments
Long-term investments will incur a considerably lower capital tax rate than short-term investments One of the most straightforward strategies to lower your capital gain taxes is to avoid short-term investments. Especially, if you fall under the lowest tax brackets of 10%, 15%. or 25%, the capital gains tax rates for short-term investments are 10%, 15% and 25%, respectively, while for long-term investment is 0%, 0% and 15%, respectively. Furthermore, 15% applies to long-term capital gains in the 25%, 28%, 33%, or 35% tax brackets.
Furthermore, when investing in securities, it is important to remember that investing in short-term with a higher interest rate may seem a wiser decision than investing in long-term with a lower rate, but after capital gains tax is collected, the long-term investment will be more profitable.
- Set money aside in retirement funds
Putting money aside in a retirement account is a great strategy to lower your capital gain taxes and save for the future. By soaking money away to a tax-deferred retirement account, such as 401k, 403b, 457, IRA or annuities, you not only preserve your retirement funds, ensuring an income stream for the future, but you also protect your investments from capital gains tax. When you reach the retirement age, the taxes you will pay will be based on the standard tax bracket, which is normally lower than when you were working.
- Capital losses
Another strategy for lowering your capital gain taxes is reporting capital losses. In fact, you sell an investment or asset at a lower price than its original purchase price. For tax purposes, you report a capital loss on items that you expected they would increase in value. For example, you buy 50 shares for $100 per share in January. By April, the stock price has declined by 15% to $85, and you lose $15 per share, which is $750. By September, the stock price rises to $90, and you decide to sell it, thus realizing a loss of $5 per share, i.e. a total of $250. In the tax report, you will report the loss of $250 as capital loss because the stock price was expected to rise further when you sold the security. Moreover, capital losses can be carried over the next years of tax returns, and you can deduct capital losses from a year that you anticipate high capital gains, thus lowering your total taxable income.
- Other important considerations
- Avoid investing in mutual funds that have historically large capital gains distributions. Sometimes, you may end up paying taxes on a mutual fund that made profits in which you have never participated.
- Consider donating appreciated securities rather than donating cash. Especially, if you’ve held them long enough, you can take advantage by writing off the entire value, and avoid capital gains on the appreciation.
- Consider investing in swap funds, which allow trading in concentrated positions in stocks in a diversified portfolio.
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