Capital gains taxes
In a previous post we discussed how a capital gain occurs when you sell an investment for a profit. All capital gains are taxable in the year that you sell your investment so you can’t normally “defer” the gain to a future year and you also don’t have to worry about any capital gains on investments that haven’t been sold yet.
One very important tax rule to be aware of is that if you incur a capital gain on an investment owned less than one year – your capital gains taxes will be significantly higher than if you owned the investment for more than one year. The capital gains on the short term investment will be taxed as normal income whereas the long term (greater than one year) gains will be taxed at a lower rate.
Capital loss taxes
Capital losses are not taxed since it is a loss rather than a gain. Why is there such thing as a capital loss if there are no taxes involved you ask? The answer is that you can use capital losses to offset capital gains to reduce your tax bill. Capital losses can be carried forward indefinitely so they don’t have to be used in the year the investment was sold.
John sold two stocks recently – one resulted in a capital gain of $3,000 which will be taxed at a rate of 15% ($450), the second stock was sold at a loss and created a $2,000 capital loss.
John can use the $2,000 loss to offset the equivalent amount of capital gains and reduce the taxable capital gain. He subtracts the $2,000 loss from the $3,000 capital gain and only pays taxes on the difference – $1,000 so he will pay $150 of tax instead of $450.