The All-in-One Guide to Capital Gains and Taxes
Tax season is stressful, there’s no way around it. Especially for all the individuals who find themselves investing for the first time, unsure about the ways investing can sometimes make taxes a tad more complicated. ⚡
However, by making taxes an integral part of your tax preparedness plan, you’ll be ready to tackle the different aspects of capital gains that can make it crazy.
Let’s get started!
First Off: What is Capital Gains Taxes?
Anytime you sell any sort of investment for a profit, that’s a capital gain. These investments include stocks, mutual funds, options, etc.
Making a profit off of any goods, service or investment means you’ll have to include it as a part of your taxable income for the tax year on your IRS tax return.
Now, there are two different types of capital gains. There are Long-Term Capital Gains and Short-Term Capital Gains.
Long-term capital gains is a term used to describe the profits you made off of investments you held for more than one year. Holding an investment for an extended period of time opens the door to lower tax rates.
Short-term capital gains is a term used to describe the profits you made off of investments you held for less than one year. This is taxed like ordinary income.
How Do I Report My Capital Gains to the IRS? 🤑
Thankfully, federal tax laws require investment companies to disclose the exact profit you made from investments in the prior tax year. If you have a Firstrade account, you should have received your 1099 form via email sometime between last January or late February. To download the document again, login to your Firstrade account and go to Account > E-Documents > Tax .
If you’re using TurboTax software to file your taxes (click here to claim your exclusive Firstrade discount on taxable investment accounts), the program will ask if you’ve received a 1099 and then provide instructions for importing the document.
You can also work with an accountant to help you determine the best methods for avoiding capital gains taxes and penalties.
Second: What are the Best Ways to Minimize Capital Gains Taxes?
Even with the most educated accountant or broker on your side, you’ll still end up having to pay a tax on capital gains. However, there are ways to lessen the blow. 💣
You probably were unaware, but you can actually utilize 401K accounts and IRAs to minimize capital gains taxes.
This is because:
Any investments within a Roth IRA account are tax exempt.
When you make a withdrawal from a Roth IRA account, it isn’t taxed.
Any contributions you make to a 401k or IRA reduce the amount of your taxable income for the year. (Which means you’ll pay less tax TODAY for any capital gain!)
Utilize Tax-Loss Harvesting for Off-Setting Capital Gains ⚖
You won’t always make a return on your investments. And not always because you did anything wrong. It’s the way the game goes. Anytime you have to sell an investment for less than you originally invested into it, you end up with what is commonly referred to as a “capital loss”.
Tax-loss harvesting can help you reduce capital gain taxes. We’ll give you a good example below.
You have an investment account, and most of your investments have made good returns. But one of your stocks has unfortunately fallen by 10% after six months. This means that if you sell at this time, you will only be able to sell at a loss. But the advantage is that you can now use this loss to offset your other capital gains to reduce the overall capital gains tax burden.
If your capital loss exceeds the capital gains, you can also use this capital loss to offset the taxable income of any tax year, up to a maximum of $3,000 per year, which is a way to reduce your income tax burden.
And no, it’s not usually this straightforward, unfortunately. That’s why we recommend hiring a professional to help you sort through your options.
