Read this if you're making money on your investments
Capital gains are great.
It means you picked a good investment and made money.
Unfortunately, it also means you have a tax bill coming.
When and how you realize these gains can be the difference between making and (in some cases) losing money on your investments.
There are two types of capital gains: short and long term.
Short term capital gains:
They get taxed at our ordinary income tax rates (the highest tax rate possible).
They are only applicable to investments held for less than a year (think day-trading or house-flipping).
They are the reason why I tell clients they are better off buying and holding investments for the long term.
Long term capital gains:
They get taxed at reduced rates (as high as 20% as low as 0%... yes 0%)
They are only applicable to investments held for more than a year.
They are the reason why I’d rather have investment income than earned.
Quick case study
If you buy a stock for $100,000 and months later sell it for $110,000 then worst-case scenario you will pay $4080 in taxes.
You just went from a 10% return to 5.9%.
Alternatively, if you buy a stock for $100,000 and wait a year to sell it (at $110,000) then best-case scenario you pay nothing and worst case you pay $2380.
Best case 10% return, worst case 7.3%.
Other notes
Advisors often suggest using capital losses (you bought for $100k and sold for $90k) to offset both earned and investment income.
Great advice.
More great advice is using capital gains, via charitable gifting, as a way to offset the same forms of income.
In practice this looks like giving away highly appreciated stocks at their market value to the charity of your choice, locking in up to a 30% tax deduction.
Instead of paying a 15%, 20%, or 23.8% tax bill you get a 30% write off.
Pretty nice.