Investing and Taxes
TL;DR: Use Retirement accounts, and in general take long-term gains and short-term losses.
When it comes to taxes, nothing’s ever simple*. However, when I started I wished someone explained this all to me. How your investments are taxed matters a lot!
We’re going to start with the very basics and work on more in the following weeks.
There are two main ways investments are taxed:
- Short-term capital gains/losses: For most investments, when you hold your position (say you buy 1 share of AAPL) for less than a year (i.e. you sell that share of AAPL back out), it becomes a short-term capital gain/loss. Whatever you make or lose is taxed at your ordinary income rate.
- Long-term capital gains/losses: When you hold your investments for over a year, you are taxed at a reduced rate**. For most people this would be 15% (although it ranges from 0-20% depending on your income bracket).
Notice that this means that while you get taxed on your investment gains, you get tax refunds when you lose money on your investments.
When you have multiple positions that were closed out where some have gains and some have losses, some short-term and some long-term, this is how your tax liability is usually calculated. You take all your short-term capital gains/losses, and add them all up (so they net out). You take all your long-term capital gains/losses, and add them all up (so they net out). Losses in one category at this point can offset any gains in the other category. The remaining balances in each category are taxed accordingly.
So when it comes to the end of the year, think about how you want to adjust your positions. If you close out your short-term losers you can claim a tax refund***. If you hold your winners until they become long-term winners you pay a reduced tax rate. You can also close out long-term losers against short-term winners to avoid paying that long-term/short-term tax rate spread.
Oh yeah, you can also avoid all this by simply using a retirement account such as a 401k or IRA, where you pay on your income but your investments can grow tax-free. These were described in a previous blog.
The More You Know.
TheJKW
*I’m not a professional, and there are always exceptions. Please consult a tax professional for specific advice. I’m giving only general advice and will give no guarantees on anything.
**Funnily enough, in 2018 if you make specifically between $38601 and $38700, your long-term capital gains are taxed at 15% but ordinary income is taxed marginally at 12%. This is the only scenario where long-term capital gains rates are higher.
***Deductions due to short-term and long-term capital losses are capped at $3,000 a year. Any more carry forward on to the next tax year.