We’d love to see 2020 one more time—in the rear-view mirror! Before we bid this abysmal year farewell, let’s talk taxes. Do you think tax rates will go up in 2021? We certainly don’t know and there are numerous ifs to consider.
- If Democrats win both Georgia Senate seats in January, and
- If the US House, Senate, and president all agree to raise (cap gains) taxes in 2021, and
- If you have capital gains from appreciated investments (that are not tax-deferred like an IRA, 401(k), 403(b) and so on), then you might consider selling some investments before the end of 2020 to save income taxes.
If you have a crystal ball or some other way to predict the future—and you expect all of the above to happen—you might decide to do some strategic selling before the end of 2020. Are we recommending this? Absolutely not! As it stands, we’re not time-travelers or Dr. Who, sadly, so we don’t know what the future brings. That doesn’t mean we, and you, can’t assess our options to make wise and thoughtful decisions about this and other tax matters.
To help you learn a little more about capital gains and what you should be thinking about at year-end, we’ve broken it down into bite-sized pieces for easy absorption.
Capital Gains (and Losses)
To best explain capital gains and losses, let’s use an example you might relate to.
Generally, it goes like this: you buy an investment, such as a stock, mutual fund or cryptocurrency, because you believe it will be worth more over time. Let’s say you invested a total of $10,000. This is your basis. The purpose of basis is to keep you from paying tax on the same thing twice. Let’s say you sell it later for $15,000, so after subtracting your basis, you’re left with a $5,000 capital gain -- a taxable gain. It’s assumed you already paid tax on the $10,000, so that part isn’t taxable again. If, on the other hand, you sold it for $8,000, you’d have a capital loss of $2,000.
While that might be a simple example, it’s also a straightforward approach to thinking about a complicated process. If you want to dive deeper, check out what the IRS has to say about it.
Taxation of Capital Gains
If you hold an investment for a year or less before selling it, you have a short-term capital gain which is taxed as ordinary income (like W-2, interest income and so on).
If you hold an investment for more than a year and then sell it, you have a long-term capital gain which is taxable at special tax rates.
Currently, long-term capital gain rates are 0%, 15% or 20%, depending upon your tax bracket. Most folks pay 15%. Once again, we defer to the experts in tax, the IRS, so head over here for more information about the rates you might pay.
Simultaneous Capital Gains and Losses
Yes, that’s a thing. So If you have both capital gains and losses in the same year, you can generally net these against each other—the net effect can reduce taxes.
However, maybe you have only capital losses for the year. If that’s the case, you can deduct only $3,000 per year against your ordinary income on your Form 1040, and the remainder gets carried forward for possible use in future years. There’s a process for netting the different types (long-term, short-term, gains and losses) that seems a little tricky at first—talk to a tax accountant to help detangle the process for you.
Personal Taxation (including pass-throughs)
Capital gain rules, briefly sketched in this blog, also apply to personal taxes which include pass-through entities. Remember, sole-proprietorships, partnerships and S-corporations are pass-through entities so income, deductions, gains, losses and credits are all passed through your business and assessed at the personal (Form 1040) level. C-corporations have a different set of rules which are not considered in this article. If you have capital gains and losses in a C-corporation, this is a good read for you.
What’s Next for Capital Gains?
Like any self-respecting business owner, you’re probably thinking, so I’ve learned what you asked me to, now what? What does it all mean for me?
Assuming capital gains rates were to go up in 2021—still don’t have a crystal ball, so that’s a big if—then selling now and paying taxes at the current, lower rates (0%, 15% or 20%, depending upon your personal tax bracket) could be beneficial because you’d pay less income taxes overall. Should you rush to sell appreciated investments before the end of the year? Probably not. The problem is we just don’t know—it’s all just so, ya’ know, iffy.
There’s a lot to consider, both tax and non-tax-wise. But if you’re still reading, you probably understand this pretty well by now and this article has achieved its objective—to help you better understand the taxation of capital gains to help you make wise decisions.
As always, when in doubt about taxation, talk with an inDinero tax pro, because while they don’t jump through space and time, they do know taxes better than Doctor Who ever could.