Don't overlook the tax consequences when you make investment
decisions.
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 Professional advisers recommend that you make investment
choices based on factors such as return on investment, level of risk, and portfolio
diversification —
not on avoiding income taxes. Still, investing your money to gain the best possible return after taxes is a vital
part of any investment strategy.
CAPITAL GAINS
A capital asset
is any property you can buy and sell. That includes stocks,
bonds,
and mutual funds,
your home and other real estate, jewelry, cars, and collectibles.
A capital gain
is the amount of your profit when you sell an asset for more than it cost you. You have
a capital loss,
on the other hand, if you sell an asset for less than you paid to buy it.
LONG- AND SHORT-TERM GAINS
If you own a capital asset for a year or less before you sell,
any appreciation,
or increase in value, will give you a short-term capital gain.
Short-term gains are taxed as ordinary income, at your regular tax rate.
But if you own certain assets, such as securities,
for more than a year before you sell at a profit, you have
a long-term
capital gain. Generally, those gains are taxed at a maximum rate of 15% if
your marginal
tax rate is 22% to 35%. If your marginal rate is 10% or 12%, capital gains are taxed at 0%.
However, higher rates do apply for people with higher incomes whose marginal rate is up to 37%.
If you file your federal income tax return as a single and have an adjusted gross income (AGI) of
$445,851 or higher in 2021, you pay a capital gains tax rate of 20%. If you are married
and file a joint return, the 20% rate applies if your AGI is $501,601 or higher.
In addition, if you file as a single and have an AGI of $200,000 or higher, you
pay an additional surtax of 3.8% on investment income, including capital gains.
If you're married and file a joint return, the 3.8% surtax applies if you have
an AGI of $250,000 or higher. In other words, there are actually the equivalent of four of five possible
capital gains rates: 0%, 15%, 18.8%, and 23.8%.
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DEDUCTING CAPITAL LOSSES
You can combine your capital gains and capital losses - short-term gains with short-term losses and long-term gains
with long-term losses —
to offset, or reduce, the gains on which you owe tax. You may even wipe out all your gains and have a net loss.
If you have a net loss, you may also be able to reduce your ordinary income, such
as your salary, but there's a cap of $3,000 per year ($1,500 if you're married
and filing separate returns). If your capital loss in any year is greater than that
amount, you can carry over the excess and deduct it against gains or ordinary income
in later years.
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HOLDING STOCKS DEFERS CAPITAL GAINS
While you're holding an investment, you don't pay tax on
any increase in its value, or what's known as
your paper profit
or unrealized gain.
The market price of a stock you bought for $5 a share may climb to $50, but the tax on that
gain is deferred until you sell the stock and collect the proceeds. At that point, your gain
is taxed at your capital gains tax rate. Of course, any profit you don't realize could
disappear if the market value of the stock or other asset drops.
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 PASSIVE INCOME
Passive income
or passive losses
come from businesses in which you aren't an active participant. These include limited partnerships,
rental real estate, and other types of activities that you don't help manage.
Losses from passive investments can be deducted from income you earn on similar
ventures. For example, you can use losses from rental real estate to reduce gains
on limited partnerships. Or you can deduct those losses from any profits you realize
from selling a passive investment. But you can't use passive losses to offset
ordinary income or capital gains. The rules governing passive income are complex.
You should consult with your own tax adviser about them.
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