Investment Tax Planning
Don't overlook the tax consequences when
you make investment decisions.
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 Professional advisers
recommend that you make investment choices based on factors such as return
on investment, level of risk, and portfolio diversification — not on
avoiding income taxes. Still, investing your money to gain the best possible
return after taxes is a vital part of any investment strategy.
CAPITAL GAINS
A capital
asset
is any property you can buy and sell. That includes
stocks,
bonds,
and
mutual funds, your home and other real estate, jewelry,
cars, and collectibles. A
capital gain
is the amount of your profit when you sell an asset for more than it cost
you. You have a capital
loss, on the other hand, if you sell an asset for less than you paid to buy it.
LONG- AND SHORT-TERM GAINS
If you own a capital asset for a year or less before you sell,
any appreciation,
or increase in value, will give you a short-term
capital gain.
Short-term gains are taxed as ordinary income, at your regular tax rate.
But if you own certain assets, such as
securities,
for more than a year before you sell at a profit, you have a
long-term capital gain.
Generally, those gains are taxed at a maximum rate of 15% if your
marginal tax rate
is 25% or higher. If your marginal rate is 10% or 15%, capital gains are taxed at 0%.
However, higher rates do apply for people with higher incomes. If you file your federal
income tax return as a single and have an adjusted gross income (AGI) of $400,000 or higher,
you pay a capital gains tax rate of 20%. If you are married and file a joint return, the
20% rate applies if your AGI is $450,000 or higher.
In addition, if you file as a single and have an AGI of $200,000 or higher, you pay an
additional surtax of 3.8% on investment income, including capital gains. If you're married
and file a joint return, the 3.8% surtax applies if you have an AGI of $250,000 or higher.
In other words, there are actually three possible capital gains rates: 15%, 18.8%, 23.8%.
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DEDUCTING CAPITAL LOSSES
You can combine your capital gains
and capital losses - short-term gains with short-term losses and long-term
gains with
long-term losses — to offset, or reduce, the gains on which
you owe tax. You may even wipe out all your gains and have a net loss.
If you have a net loss, you may also be able to reduce your ordinary income,
such as your salary, but there's a cap of $3,000 per year ($1,500 if you're
married and filing separate returns). If your capital loss in any year is
greater than that amount, you can carry over the excess and deduct it against
gains or ordinary income in later years.
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HOLDING STOCKS DEFERS CAPITAL GAINS
While you're holding an investment, you don't pay tax
on any increase in its value, or what's known as your
paper profit or
unrealized gain. The market price of a stock you bought
for $5 a share may climb to $50, but the tax on that gain is deferred until
you sell the stock and collect the proceeds. At that point, your gain is
taxed at your capital gains tax rate. Of course, any profit you don't realize
could disappear if the market value of the stock or other asset drops.
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 PASSIVE INCOME
Passive income
or passive losses come from
businesses in which you aren't an active participant. These include limited partnerships, rental
real estate, and other types of activities that you don't help manage.
Losses from passive investments can be deducted from income you earn on similar ventures. For
example, you can use losses from rental real estate to reduce gains on limited partnerships. Or
you can deduct those losses from any profits you realize from selling a passive investment. But
you can't use passive losses to offset ordinary income or capital gains. The rules governing
passive income are complex. You should consult with your own tax adviser about them.
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