We have seen that the stock market has hit several new highs in recent months. This is in addition to the fantastic bull market that ran for more than ten years before the rapid coronavirus bear market. We hope that in 2021 we will continue to see the U.S. financial market reach historic levels. Substantial gains in the stock market are amazing for your net worth but can lead to painful capital gains tax accounts when you finally sell your investment. The amount of tax on investment income will depend primarily on two factors: how much your investment has grown and how long you hold your investments.
When you sell an investment (mutual funds, bonds, stocks, ETFs, real estate) for more than its cost basis (what you paid for it), your net income will be taxed as a short-term capital gain or long term.
Whether your investment income is taxed as long-term capital gains or short-term capital gains depends on how long you hold your shares in each investment. The period to be considered is one year. If you hold the investment (or even just a few shares of the investment) for a year or less, you will experience short-term capital gains. For assets held for more than one year and one day, capital gains will be taxed as long-term capital gains.
Long-term capital gains vary in 2021
Let's see how long-term gains are taxed. In many cases, long-term capital gains will be favorably taxed. This means that you will likely pay less tax on long-term capital gains than on other types of income, like wages. Long-term capital gains are taxed at 20%, 15%, or 0% rates, depending on the combination of taxable income and marital status.
For one-time contributions, you may qualify for a zero percent capital gain rate if you have an income of less than $ 40,400 in 2021. Most singles will fall into the 15% capital gain rate, which applies to income between $ 40,401 and $ 445,850. Individuals with over $ 445,850 will be affected by the 20% long-term capital gain rate.
The parentheses are slightly bigger for couples filing jointly, but most will be affected by the marriage tax penalty here. Married couples with combined incomes of $ 80,800 or less remain in the 0% tax category, which is great news. However, couples earning between $ 80,801 and $ 501,600 will have a capital gain rate of 15%. Those with an income of over $ 501,600 will have a long-term capital gain rate of 20%.
Additional Medicare taxes for higher-income earners
There may be additional taxes or a loss of tax deductions for those with higher incomes. For example, married taxpayers with income over $ 250,000 must also pay a surtax in addition to the net investment of 3.8%. (The Medicare surtax applies to income over $ 200,000 for individual taxpayers.) This Medicare surtax applies to all investment income, whether the capital gains are short-term or long-term capital gains.
Short-term capital gains
Short-term capital gains are usually taxed as ordinary income. If you possess an investment for less than a year, any gains or losses will be treated as short-term losses or short-term gains. The good thing is that up to $ 3,000 in short-term losses can be deducted from regular income each year. This provides a great opportunity to reduce taxes by recovering tax losses.
Taxes on investments in retirement accounts
Income from 401 (k), traditional I.R.A., defined benefit pension plan, 403 (b), and tax-sheltered annuities (T.S.A.) will be tax-exempt. You will most likely not be required to pay taxes on retirement accounts until there is a withdrawal. If you have a Roth 401 (k) or a Roth I.R.A., your withdrawal will be tax-exempt, assuming you comply with the Internal Revenue Service (I.R.S.) rules.
The rules for capital gains are slightly different when selling real estate holdings.
Taxation of real estate capital gains
The rules for capital gains are different when you own a property. There are two main tax rules to know when it comes to property sales tax.
When you sell your primary residence, you can avoid paying a large amount of income tax. Single homeowners can exclude capital gains of up to $ 250,000 from the sale of their main residence. This number increases to $ 500,000 for a couple selling their primary residence. There are a few rules that you must follow to get this tax reduction; in particular, you must have resided in the primary residence for at least two of the past five years.
Remember that taxable income is based on your home's cost, which is not the same as the purchase price. So keep track of any upgrades or remodeling projects you've spent money on to improve your home that could increase your cost basis. The higher the basis price, the lower the tax bill will be when you finally sell your home. For example, if you bought a house in Beverly Hills for $ 6 million and then spent $ 7 million on it to remodel it, it would have a $ 7 million basis cost. If you are married and have lived there for two of the past five years, you can sell it for $ 7.5 million without paying capital gains tax for sale.
The rules are slightly different for real estate investments. You will owe the capital gains tax on the sale's net profit, but you will also owe the gains on any accumulated depreciation benefits received while you own the property. This process is called depreciation recovery. It's a very complicated subject to discuss here, completely. You need to know that the cost basis in real estate investing is probably lower than what you invest in properties. Speak to your certified financial planner and C.P.A. before selling your real estate investment to ensure you understand the tax consequences.
Should You Avoid Short-Term Capital Gains?
Taxes should always be part of the equation when making decisions about whether to hold or sell investments. That being said, you need to know how long you've owned the investment and try as much as you can to avoid short-term capital gains. The I.R.S. tax code encourages long-term investing or maintaining investment for at least one year. In some cases, long-term capital gains rates will be lower than income tax rates.
Bottom Line
Tax planning should never be the sole determining factor in an investment strategy. But it can be a factor. If possible, holding your investments for more than a year before you even consider selling them can be a big plus for paying taxes on your capital gains.
Whether you need to raise investments for an I.R.A. distribution or just because you need income, special tax treatment for capital gains can also help you determine which specific properties to sell and when. You would be selling the ones that are considered long-term profits at the lowest tax rate.
FOR MORE INFORMATION OR TO MAKE AN APPOINTMENT TO SEE HOW WE CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CONTACT Rosovich & Associates, Inc., BY CLICKING THE BLUE TAB ON THIS PAGE.
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Rosovich & Associates, Inc.