Trading goods is, in fact, one of the most common ways for people not only to make side money, but also to make a career and even build wealth out of it. “Buy low sell high” is the way to go right? It is indeed… partially true especially you are living under Uncle Sam’s operations. Remember that every time someone or any company starts to make some profits, they will need to put money on aside to pay for capital gain taxes. We don’t like it but sadly it is a must.
In this article, we will explore the basics of capital gain taxes, including what they are, how they are calculated, and strategies for minimizing their impact on your investment returns. By understanding capital gain taxes, investors can make more informed investment decisions and maximize their after-tax returns.
Yes, even though it is not directly relating to Real Estate, you will thank me later for helping you be aware and understand the concept of Capital Gains. Besides this article, I highly encourage everyone to invest some time to read one of the most recommended personal finance book, Rich Dad Poor Dad by Robert T. Kiyosaki. A $10 book may save you thousands of dollars in tax payments.
What is Capital Gain Taxes?
Capital gain taxes are taxes levied on the profit made by selling an asset for a higher price than the original purchase price. These taxes are calculated based on the difference between the sale price and the purchase price of the asset and can vary depending on the length of time the asset was held, the investor’s income level, and other factors.
Capital gain taxes can have a significant impact on an investor’s net returns, making it essential to understand how they work and how to minimize their impact.
The Two Types of Capital Gain Taxes
There are two types of capital gain taxes that we need to be aware of, short-term and long-term capital gain. Here’s a short and simple definition for each:
- Long-term capital gain: refers to the profit made by selling an asset that has been held for more than one year. The tax rate for long-term capital gains is generally lower than the tax rate for short-term capital gains.
- Short-term capital gain: On the other hand, refers to the profit made by selling an asset that has been held for one year or less. Short-term capital gains are taxed at a higher rate than long-term capital gains.
Keep in mind that the holding period or the timing using for these definitions is the amount of time that the asset is owned before it is sold. Therefore ,investors really need to consider the timing of their sales to determine whether they will be subject to long-term or short-term capital gains taxes. This can be especially important when selling assets with significant gains.
What are the Rates for both Options?
So now that we all understand the key differences between the two. You may ask yourselves and us which one should you be leaning toward?
Let’s take a look at the difference tax brackets for each option for the year of 2022 (thank you TurboTax for the beautiful tables)
2022 Short-Term Capital Gains Tax Rates
| Tax Rate | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
| Filing Status | Taxable Income | ||||||
| Single | Up to $10,275 | $10,276 to $41,775 | $41,776 to $89,075 | $89,076 to $170,050 | $170,051 to $215,950 | $215,951 to $539,900 | Over $539,900 |
| Head of household | Up to $14,650 | $14,651 to $55,900 | $55,901 to $89,050 | $89,051 to $170,050 | $170,051 to $215,950 | $215,951 to $539,900 | Over $539,900 |
| Married filing jointly | Up to $20,550 | $20,551 to $83,550 | $83,551 to $178,150 | $178,151 to $340,100 | $340,101 to $431,900 | $431,901 to $647,850 | Over $647,850 |
| Married filing separately | Up to $10,275 | $10,276 to $41,775 | $41,776 to $89,075 | $89,076 to $170,050 | $170,051 to $215,950 | $215,951 to $323,925 | Over $323,925 |
2022 Long-Term Capital Gains Tax Rates
Tax Rate | 0% | 15% | 20% |
| Filing Status | Taxable Income | ||
| Single | Up to $41,675 | $41,676 to $459,750 | Over $459,750 |
| Head of household | Up to $55,800 | $55,801 to $488,500 | Over $488,500 |
| Married filing jointly | Up to $83,350 | $83,351 to $517,200 | Over $517,200 |
| Married filing separately | Up to $41,675 | $41,676 to $258,600 | Over $258,600 |
Long story short, you will most likely get taxed more for short-term capital gain simply because it will be taxed at the same rate as your ordinary income. For any further clarification, please check with your tax professionals.
So why would people even sell their assets short-term and get taxed more?
Besides the facts that not everyone is fully aware of this piece of information or simply didn’t even know that they have to pay tax on any sort of capital gain, each investor has his/her own risk tolerance and goals when it comes down to investing strategies and holding period. For example, if you are a full-time stock trader, most likely you’ll have to transact much more frequently to maximize your return due to greater market volatility so the holding period will be considered short-term. Additionally, most people are not able to hold their funds in asset forms for a long-time for personal reasons and there’s nothing wrong with it. Gains are still gains as long as you’re willing to pay your due diligence. At the end, who are we to judge?
Overall, investors should consider both long-term and short-term capital gains when developing their investment strategies. By understanding the differences between the two and weighing the risks and rewards, investors can make informed decisions that align with their financial goals.
Why is it Important to Understand Capital Gain Taxes?
Even though it is mostly unavoidable for most people (yes, I am generalizing), it is extremely important for all of us to fully understand the basic fundamentals of capital gain taxes and how to use it to your advantages, especially if you are and plan to enter real estate investing.
Here are some of the key reasons why it’s essential to understand these taxes:
- Compliance: Let’s get the boring stuff out of the way! Investors need to comply with tax laws and regulations related to capital gain taxes. Failure to comply can result in penalties, fines, and legal issues. Paying tax is one thing. Paying the correct amount is another thing.
- Investment strategy / Profitability: Just like any other line items, taxes are considered an annual expense. Investors need to consider capital gain taxes when developing an investment strategy. This includes determining the optimal holding period for an asset, weighing the tax implications of buying and selling an asset, and deciding which assets to invest in to maximize after-tax returns. If not done correctly or carelessly, investors may end up with much lower return on the investment than expected.
- Planning and budgeting strategically for your investments: Understanding capital gain taxes can help investors plan and budget their finances more effectively. For example, investors may want to set aside a portion of their capital gains to pay for taxes, which can help them avoid any unexpected tax bills or allocate a specific portion of the gains toward other expenses items that can help yield higher return for the next year.
- Long-term financial planning personally: Capital gain taxes can have significant long-term financial implications, especially for high-net-worth investors. Understanding these taxes can help investors plan for their retirement and other long-term financial goals.
Understanding capital gain taxes is crucial for investors to develop effective investment strategies, plan and budget their finances, comply with tax laws, and achieve their long-term financial goals. Note that I am not a Certified Public Accountant and this article is for educational purpose only. To effectively strategize or to get any additional clarifications, please consult with a tax professional.
Conclusion
In conclusion, capital gain taxes are an important consideration for investors looking to make a profit from buying and selling assets. These taxes are levied on the profit made by selling an asset for a higher price than the original purchase price and can significantly impact an investor’s net returns.
To minimize the impact of capital gain taxes, investors can use strategies such as holding assets for the long term, using tax-advantaged accounts, and timing the sale of assets strategically. Understanding capital gain taxes and how to minimize their impact is essential for investors to make informed investment decisions and maximize their after-tax returns. By seeking professional advice and taking a strategic approach to capital gain taxes, investors can achieve their financial goals while minimizing their tax burden.
Once again, we are not certified public accountants and this article is only for education purpose. However, if you are in need of a great tax professional, you can reach out to us at info@chadvorealestate.com and we will be more than happy to provide you with a list of recommendations. But at the end, please do us a favor and seek some professional consultations with a tax professional. It is indeed one of the best investments you can make.