Pending a possible change to the tax laws, as of now (August 11, 2010) the capital gains tax rates (the tax you pay in gains in your investments) are subject to increase starting in 2011. For some investors that means it might be beneficial to sell stocks with gains this year in order to reduce taxes (everyone’s situation is different and LOZO doesn’t recommend any specific course of action…consult a financial advisor!). It’s important to understand one basic rule that governs the tax rates, so that you achieve the best return on your investment.
The difference between short term (less than 1 year) and long term capital gains taxes (the tax you pay on any gains on your investments) can be significant, especially in higher tax brackets. Be smart about when to sell – if you are close to the 1-year window it might pay to hold on to the investment a little longer to guarantee a lower tax.
For example, if you have an investment that you bought for $100 and are ready to sell for $200, you’ll have to pay capital gains taxes on the $100 profit. If you are in the 33% income tax bracket and have held that investment for less than a year, you’ll pay $33 in federal taxes. If you’ve held for more than a year, you’ll pay just $15. That’s an 18% difference on investment returns that stays in your pocket.
2010 Capital Gains Tax Rates
| Tax Bracket | Short Term Rate | Long Term Rate |
| 10% | 10% | 0% |
| 15% | 15% | 0% |
| 25% | 25% | 15% |
| 28% | 28% | 15% |
| 33% | 33% | 15% |
| 35% | 35% | 15% |
Of course, don’t hold onto an investment for an entire year just for the lower capital gains, since it can lose value that offsets the tax difference in the meantime. But if you are close to the 1-year window it might make sense to wait the extra few days to lock in your tax savings and extra profit. Consider the risks of the investment dropping versus the certain tax relief.
Be careful to avoid a wash sale (buying and selling the same stock or fund type within a 30 day period) which can trigger the higher tax rate when selling a losing investment (though you may not run into this when selling a gaining investment). Inversely you might be able to offset some short-term gains (and the higher taxes they bring) by booking some losses that you may have incurred. Mutual funds pay out dividends – and create tax liability – on established dates so know them before you buy to avoid an unpleasant surprise. Consult a financial advisor.
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A LOZO expert posted this tip. |