Capital Gains

Capital gains are profits realized from selling investments like stocks, bonds, or real estate for more than their cost basis. They represent the difference between what you paid for an asset and what you received when you sold it.

How Capital Gains Work:

• Calculated as: Sale Price
• Cost Basis = Capital Gain
• Only realized when you actually sell the investment
• Subject to capital gains tax rates
• Can be offset by capital losses
• Different tax rates for short-term vs. long-term holdings

Types of Capital Gains:

• Short-Term: Held for 1 year or less, taxed as ordinary income
• Long-Term: Held for more than 1 year, taxed at preferential rates
• Realized: Actual gains from selling investments
• Unrealized: Paper gains on investments you still own

Tax Rates (2024):

• Short-Term: Same as your income tax bracket (10%-37%)
• Long-Term: 0%, 15%, or 20% depending on income
• Additional 3.8% Net Investment Income Tax for high earners

Income Thresholds for Long-Term Rates:

• 0%: Single up to $47,025, Married up to $94,050
• 15%: Single $47,025-$518,900, Married $94,050-$583,750
• 20%: Single over $518,900, Married over $583,750

Capital Losses:

• Can offset capital gains dollar-for-dollar
• Up to $3,000 in excess losses can offset ordinary income
• Unused losses carry forward to future years
• Wash sale rules prevent artificial losses

Tax Planning Strategies:

• Hold investments for more than 1 year for lower rates
• Harvest losses to offset gains
• Time sales to manage tax brackets
• Consider tax-loss harvesting in December
• Use specific identification for cost basis

Cost Basis Adjustments:

• Stock splits adjust your cost basis proportionally
• Dividend reinvestment increases cost basis
• Return of capital reduces cost basis
• Keep detailed records of all adjustments

Reporting Requirements:

• Form 8949 for each sale transaction
• Schedule D for summary of gains and losses
• Broker provides Form 1099-B with sale details
• Maintain records for at least 3 years after filing

Special Situations:

• Wash Sales: Can't claim losses on identical securities bought within 30 days
• Gift Tax: Recipient inherits your cost basis
• Inheritance: Step-up in basis to fair market value at death
• Like-Kind Exchanges: Defer gains on real estate exchanges

Investment Strategies:

• Consider tax implications in investment decisions
• Use tax-advantaged accounts (401k, IRA) to defer taxes
• Consider municipal bonds for tax-free income
• Plan asset location across taxable and tax-deferred accounts

Record Keeping:

• Track purchase date, price, and number of shares
• Record all cost basis adjustments
• Keep dividend reinvestment records
• Maintain documentation for at least 3 years

Common Mistakes:

• Forgetting to adjust cost basis for splits
• Not tracking dividend reinvestments
• Ignoring wash sale rules
• Poor record keeping leading to overpayment

Capital gains are a key component of investment returns and tax planning. Understanding how they work helps you make better investment decisions and minimize your tax burden.