How do capital gains taxes work?

Capital gains tax applies to the profit made when selling an asset, calculated as the difference between the purchase price and the selling price. One key factor in determining the tax rate is the holding period of the asset.

Long-Term vs. Short-Term

The tax treatment depends on how long an asset is held before being sold. Assets held for more than a year qualify for long-term capital gains tax rates, which are set at 0%, 15%, or 20%, depending on overall income. In contrast, assets sold within a year are subject to short-term capital gains tax, which follows ordinary income tax rates and can be significantly higher.

Tax Efficiency Through Netting Gains and Losses

A strategic way to manage capital gains tax liability is by netting gains against capital losses. This process allows taxpayers to offset profits with losses, reducing taxable income. If losses exceed gains in a given year, the excess can be carried forward to future tax years, providing continued tax benefits.

Unique Advantages

Capital gains tax offers a more favorable tax treatment compared to ordinary income tax, particularly for long-term investments. By understanding the differences in tax rates and utilizing strategies like loss carryforwards, investors can optimize their tax efficiency and potentially lower their overall tax burden.

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Shawna Theriault, CFP®, CPA, CDFA®
Senior Financial Advisor, Wiser Wealth Management

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