What You Need to Know About Capital Gains, Losses Before Tax Season

By Mark Yatros 

Capital gains. Capital losses. Short-term gains. Long-term gains…

It’s not surprising if just the mention of the terms above causes you to tune out. The whole subject sounds dull and dry. And why should you care, anyway?

You should care because capital gains and losses impact how much tax you pay and when you pay it.

Consider this: My colleagues and I often review our clients' tax returns and find ways to lessen their losses or enhance their gains. Sometimes, this leads to significant tax savings. 

If you’d like individual guidance on how capital gains and losses impact your taxes, we’d be happy to review your returns for missed opportunities. You can contact us here or call (269) 218-2100.

But first, let’s define capital gains and losses. 

Capital gains and losses refer to the profits and losses you make from selling certain assets, like stocks or real estate. Imagine buying a share of your favorite company's stock at $50 and selling it a year later for $70. Congratulations! You've just made a capital gain of $20. On the other hand, if you sell an asset for less than what you paid for it, that's a capital loss.

These gains and losses directly impact how much tax you owe the government. By understanding the ins and outs of capital gains and losses, you can make informed financial decisions and potentially reduce your tax burden.

Let's dive in and discover how capital gains and losses can influence your tax bill. 

What Are Long-term and Short-term Capital Gains?

There are two types of capital gains: short-term and long-term. Short-term gains happen when you sell an asset you've owned for one year or less, while long-term gains come from selling assets held for more than one year.

Capital gains can stem from various types of assets. For example, if you bought one acre of land for $100,000 and sold it later for $150,000, you'd have a capital gain of $50,000. Likewise, if you invested in mutual funds and their value increased over time, the profit you make when selling them would be considered capital gains. Remember, it's not just about making gains; it's also crucial to understand the holding period for potential tax advantages.

Pro tip: Keep track of your investment purchase and sale dates and consider the holding period for potential tax advantages.

How Capital Gains Impact Your Taxes

Now let's explore how capital gains can influence your tax situation. 

When it comes to taxes, the government wants its fair share of your gains. The tax you pay on your capital gains depends on how long you had the asset and your income level. If you sell an asset you've owned for one year or less, it's considered a short-term gain and is taxed at your ordinary income tax rate.

On the other hand, if you hold an asset for more than one year, it's classified as a long-term gain, and you might qualify for lower tax rates.

Understanding the concept of "basis" is crucial when calculating your gains or losses. The basis is the amount you initially paid for an asset, including any additional costs like commissions or fees. When you sell an asset, you subtract the basis from the selling price to determine your gain or loss.

Please note that keeping good records of your purchases and sales is essential, as they will help you accurately calculate your gains and losses when tax time rolls around.

Now, here's where it gets interesting. The tax rates for capital gains are generally lower than ordinary income tax rates. The exact tax rates depend on your income level; the higher your income, the higher the percentage you’ll pay on capital gains. For example, if you're in the lowest income bracket, you could pay zero taxes on your long-term capital gains. However, if you fall into a higher income bracket, the tax rate can increase to 20%.

Pro tips: To minimize the impact on your tax bill, consider holding onto your investments for more than a year to take advantage of those potentially lower tax rates. Also, if you're unsure about the basis of an asset, consult your brokerage statements or reach out to a financial professional for guidance.

What is a Capital Loss?

Now let’s consider the other side of the coin – capital losses. A capital loss occurs when you sell an asset for less than what you paid for it. For example, if you bought a vacation condo for $300,000 and sold it three years later for $275,000, you’ve realized a $25,000 capital loss.  

While capital losses hurt, there are upsides because losses can help offset your capital gains for tax purposes. So, if you had a capital gain of $1,000 and a capital loss of $500, your net gain would be reduced to $500. It's a silver lining in the world of investments

It’s important to note that there's a limit to how much capital loss you can deduct each year. For 2023, the maximum annual capital loss deduction is $3,000 for individuals and married couples filing jointly or $1,500 for married individuals filing separately. But, if your losses exceed the annual limit, you can carry over the remaining amount to future years and deduct them then.

Pro tip: Keep records of your capital losses because they can potentially help offset future gains or even be deducted against other types of income, like your salary.

Netting Capital Gains and Losses

Determining your net capital gain or loss may seem complicated, so let’s simplify it. To calculate your net gain or loss, you'll add up all your capital gains and subtract any capital losses you experienced during the year. For instance, if you made a $2,000 gain from selling stocks and had a $1,000 loss from selling a different investment, your net gain would be $1,000. You'll have a net capital loss if your losses exceed your gains.

Here's an important rule: When netting capital gains and losses, the losses are used to offset the gains in a specific order. First, short-term losses offset short-term gains, while long-term losses offset long-term gains. If you still have losses left after offsetting same-term gains, you can use them to offset gains of the opposite term. For example, if you have excess short-term losses, you can use them to offset any long-term gains.

Pro tip: Regularly review your investment portfolio to identify potential capital gains and losses. By staying informed about the performance of your investments, you can make timely decisions that optimize your tax situation. Consider consulting with a financial advisor or tax professional to understand the implications of different scenarios and make informed choices.

Relief for Selling Your Home

If you’re concerned about selling your home at a significant profit and paying taxes on the gain, you can rest easy.

Primary homes (i.e., not vacation homes) are taxed differently from other investments. When you’ve lived in your principal residence for more than two years, you won’t pay taxes on the first $250,000 in capital gains if you’re single, and the amount doubles to $500,000 if you’re married.

Still Have Questions About Capital Gains and Capital Losses? Seek Assistance

Because this information is for guidance only, you may benefit from a review of your tax returns.

While our team doesn’t provide tax advice, we can review your 2022 return and possibly identify missed deduction opportunities. This is true even if an accountant prepared your return because we look at your return from a financial investment point of view. If we find a missed opportunity, you can amend your return and get your money back.

We can even look at your holdings and recommend changes you can make now to lessen the impact of capital losses or enhance the effect of capital gains on this year’s taxes.

To schedule a review, contact us here or call (269) 218-2100. 

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to ensure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Allegiant Wealth Strategies offers securities and advisory services through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Allegiant Wealth Strategies has offices in Battle Creek and Portage, Michigan, from which we serve Calhoun County, Kalamazoo County, and Kent County (Grand Rapids). The Allegiant Wealth Strategies team offers no-obligation financial planning consultations; call 269-218-2100 or contact us here.