With the end of 2015 approaching, you may be assessing your personal income tax situation and looking for tax planning strategies that will work to your favor. Have you considered the potential for tax savings related to capital gains and losses?
Most taxpayers understand that their income levels and filing status determine their marginal (ordinary) tax bracket, with tax rates ranging from 10 percent to 39.6 percent. These tax rates apply to sources of ordinary income, such as salary, self-employment income, business income, interest income and certain sources of retirement income.
However, capital gain income may be subject to rates that are lower than ordinary tax rates. Capital assets commonly include property held for investment, such as stocks, bonds and mutual funds. The tax rate on long-term capital gains can range from zero percent to 20 percent, depending on your taxable income.
Awareness of the different tax rates and evaluating the nature of your capital gains can help you take advantage of the preferential capital gain tax rates, utilize capital losses to offset capital gains and provide an opportunity for tax savings.
What are the different capital gains tax rates?
The long-term capital gains tax rate of zero percent applies to taxpayers with taxable income less than $74,900 for “Married Filing Joint” and less than $37,450 for single filers.
The long-term capital gains tax rate of 15 percent applies to taxpayers with taxable income between $74,901 and $464,850 for “Married Filing Joint” and between $37,451 and $413,200 for single filers.
The maximum long-term capital gains tax rate of 20 percent applies to taxpayers with taxable income over $464,851 for “Married Filing Joint” and over $413,201 for single filers.
What is the difference between short-term and long-term capital gains and losses?
A capital gain or loss occurs upon the sale or exchange of property and equals the difference between the sales proceeds and your basis in the property, which typically is the amount you paid for it.
A capital gain or loss is categorized as short-term when the property is owned or held for one year or less before it is sold. Property held for more than one year is categorized as long-term. The holding period generally begins the day after the property is acquired and ends as of the day the property is sold.
It is important to know that net long-term capital gains qualify for the lower tax rates and net short-term capital gains are taxed at your ordinary tax rates. For this reason, if you are going to sell an investment at a gain, it may be beneficial to hold onto it for more than a year before selling so the gain can qualify for long-term treatment.
In order to determine the tax treatment of your capital gains, you will first need to net the gains and losses. Capital losses offset capital gains, but only up to $3,000 of net capital loss can be used to offset ordinary income in each year.
Excess losses are carried forward within the short-term or long-term category from which they originated to offset future capital gains until fully utilized.
Capital gains and losses are first netted against each other within their respective short-term or long-term categories. When there is both a net short-term gain and a net long-term gain, the short-term gain is taxed at ordinary rates and the long-term gain is taxed at capital gains rates.
An overall net short-term gain can result when net short-term gains exceed, or absorb, net long-term losses. An overall net long-term gain can result when net long-term gains exceed net short-term losses.
How can losses help reduce my tax liability?
Capital losses offset your capital gains dollar for dollar. Capital gains are essentially tax-free when fully absorbed by capital losses.
You may want to consider whether your investment portfolio provides an opportunity to recognize capital losses to partially or fully offset gains. Also, since net capital gains are included in your taxable income, they factor into several tax deduction limitations and phase-outs that are based on income levels.
There are additional tax implications and variables to consider beyond the general concepts covered in this article. A detailed analysis may be necessary to determine the specific tax impact that will apply to your situation.
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