My goal with this post is to give a short primer on the tax treatment of capital gains and losses. You’ll notice quite a few “generallys” and “usuallys” in my post because there are lots of exceptions and gotchas in the tax law. But, I do think that information and learning is a good thing, especially in regards to your own money, so I hope this post will help you. Our CPAs know all the ins and outs of the tax law, so if we can help you with the tax implications of your investments, please give our office a call at 770-478-7424.
In the tax world, there are all sorts of different types ways that you can get or lose money.
There’s ordinary income, which would be things like the money that you earn from a job or most interest that you would receive from a bank. Ordinary income is usually taxed at one of 6 tax brackets ranging from 10% to 35%.
There’s dividends — which is when a company distributes its earnings to its stock holders.
And then there’s capital gains, which would be (generally) the amount that you made on a sale of a capital asset such as a stock or mutual fund minus the purchase price. If you sell your capital asset for less than what you bought it for (generally) then that is a capital loss. There are special rules for selling of collectibles like antiques or art.
The IRS then divides up capital gains into short-term and long-term. If you sell an asset less than a year after you bought it, then it is a short term capital gain/loss. Similarly, if you’ve owned it for longer than a year, then it is long term.
OK, now that we’ve got the vocabulary down, lets try and lower your taxes as much as possible for 2011….
If you lost money in the stock market or in investment real estate in 2011, you may have other investment assets that have appreciated in value. You should consider the extent to which you should sell appreciated assets (if their value has peaked) and thereby offset gains with pre-existing losses.
Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses must be used to offset short-term capital gains before they are used to offset long-term capital gains. If you are not a corporation, you may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing AGI.
For 2011 and 2012, a noncorporate taxpayer is subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. On the other hand, most long-term capital gains are taxed at a maximum rate of 15%. However, for 2011 as well as 2012, the maximum rate is 0% to the extent the gain would otherwise be taxed at a rate below 25% if it were ordinary income. Restricting annual payouts from retirement plans and IRAs to the required minimum distribution (RMD) (and taking cash from other accounts as needed) may help some taxpayers to take advantage of the 0% capital gains rate.
To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, you should take steps to prevent those losses from offsetting those gains.
If you have no net capital losses for 2011, but you expect to realize such losses in 2012 well in excess of the $3,000 ceiling, you should consider shifting some of the excess losses into 2011. That way the losses can offset 2011 gains and up to $3,000 of any excess loss will become deductible against ordinary income in 2012.
I hope this helps, and I will be sharing a few more 2011 tax planning strategies in the coming days.