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Capital Gains Taxes Explained: Short-Term Capital Gains vs. Long-Term Capital Gains - YouTube
Channel: TD Ameritrade
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One of the main ways to profit from
investing is to buy assets at one price
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and then sell them at a higher price.
These types of profits are known as capital gains.
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As with most kinds of profits, they鈥檙e subject
to taxes. Taxes can impact the growth of your
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portfolio, so it鈥檚 important to understand how
capital gains taxes work and learn some strategies
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to potentially minimize them. Let me note up front
that in this video we鈥檙e just covering the basics.
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Taxes can be complex and vary based on
a lot of factors, so it鈥檚 always best
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to consult the IRS or a tax professional
to understand your specific situation.
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We鈥檒l start with a simple example. Let's say
you鈥檙e an average investor and have a regular
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taxable brokerage account. You buy a share of
stock XYZ for $50, and over the course of a year,
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it increases to $60. At this point, you鈥檝e
gained $10, but it鈥檚 an unrealized gain,
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because you don鈥檛 actually profit until your
position is closed. No matter how long you hold
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the stock or how much its price changes, you won鈥檛
be taxed on gains as long as you don鈥檛 close the
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position and gains remain unrealized. Note that
other types of income from stocks, like dividends,
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may still be subject to taxes, but these
may not be considered capital gains.
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Now, back to our example. Let鈥檚 say
you decide to sell the stock at $60.
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That is considered a realized
capital gain and is a taxable event.
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You now owe taxes on the $10 profit.
We鈥檙e focusing on stocks in this video
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but be aware that capital gains taxes also apply
to other types of investments like real estate,
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bonds, and mutual funds.
So, how much are capital gains taxed?
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It mainly depends on two factors: how long
you held the investment and your income level.
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There are two types of capital gains: short term
and long term. Proceeds from investments you sell
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after holding for a year or less are generally
classified as short-term capital gains.
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They鈥檙e typically taxed at the same rate as
your ordinary income, which is determined by the
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marginal tax bracket you fall into. For reference,
marginal tax rates for the 2020 tax year ranged
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from 10% to 37%, but rates can change over time,
so it鈥檚 best to check with the IRS for specifics.
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Proceeds from investments held for more than a
year are typically classified as long-term capital
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gains. They鈥檙e usually taxed more favorably
because the U.S. government views them as
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providing economic benefit. The specific
rate may still vary based on your income,
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but for reference, the 2020 long-term capital
gains rate did not exceed 15% for most people.
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Again, rates can change over time, so it鈥檚 best
to check with the IRS or a tax professional.
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In most cases you report capital gains for
the year as part of your annual tax return,
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which could increase your tax liability when
you file. If you realized any gains, it may
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be a good idea to have money set aside in case
you have to pay. Because taxes can significantly
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impact the performance of your portfolio, it's
important to be proactive in tax planning.
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Here are a few strategies you can follow.
First, weigh the pros and cons of short-term
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investments versus long-term investments.
Active investors may attempt to increase
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returns by quickly buying and selling investments.
However, because of increased taxes and fees,
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it鈥檚 difficult for most people to outperform
a well-diversified portfolio of long-term
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investments that are almost always taxed at
a lower rate. When planning your investment
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strategy, consider how the investment
holding period can affect your tax bill.
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Second, consider maximizing tax-advantaged
accounts, like retirement and education accounts.
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Depending on the type of account, you may be able
to buy and sell investments without being subject
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to capital gains taxes. Reducing your tax burden
could potentially help your portfolio grow faster.
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Third, in taxable accounts,
make the most of your losses.
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Benefiting from losses may sound counterintuitive,
but the IRS actually allows you to write off
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certain trading losses, which can help offset some
of your capital gains taxes. For example, tax-loss
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harvesting is a strategy that involves closing
certain positions to intentionally realize losses
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that reduce your tax liability. Many brokerages
offer automated tax-loss harvesting services,
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but it鈥檚 not right for everybody, so be sure
to check with a tax or financial advisor.
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Of course, tax planning and some capital
gains calculations can be confusing.
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That鈥檚 why even seasoned investors
enlist the help of tax professionals
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to make sure their taxes are in order.
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