When the market took a nosedive at the start of the coronavirus pandemic, did you dive into the stock market for the first time? Did you sell some of your holdings? Or did you start buying more? Or did you do a bit of both?
Millions of Americans dove into the stock market and took advantage of low stock prices for the first time and millions also sold stock this year.
You may be wondering “what are the tax implications of buying and selling stock?” or “what is the difference between long term and short-term capital gains?” and “how can I save money on my taxes when I sell stock?”
If you bought and sold stock during a market downturn, here are answers to some of your questions and money-saving tips so you aren’t caught off-guard unexpectedly when tax time comes around.
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Taxes on Capital Gains
If you sold shares of winning stock, you’ll be on the hook for any capital gains you may have created. One thing to keep in mind when selling during a downturn is that depending on how long you’ve held the stock, you may be sitting on a tidy gain even if it has fallen from its previous highs.
For example, let’s say you sell a stock at $80 a share, down 20% from the $100 per share price it had in February. In your mind, you may think of it as a stock that has lost value and a good candidate for sale but always look at your history. If you bought that stock 10 years ago at $20 a share, you won’t have a $20 per share loss on the sale, but a $60 gain.
If you own 100 shares of the stock, you’ll have purchased it for $2,000. By selling at $8,000, you will recognize a $6,000 long term capital gain for tax purposes.
If you’re in the 15% long-term capital gains tax rate bracket, federal taxes on the stocks you sold will be *$900. (You may have an additional tax liability for state income tax purposes too).
*Note, you may not owe this entire amount once you take your tax deductions and credits you are eligible for into consideration.
Long-term vs. Short-term Capital Gains
If you have a gain on the sale of a security you’ve held for more than one year, you’ll get the benefit of lower long-term capital gains tax rates (0%, 15%, or 20%) depending on your income. But if the same gain comes from the sale of stock held for one year or less, that will be taxed as a short-term capital gain, which is the same rate as ordinary income tax rates (10%, 12%, 22%, 24%, 32%, 35% or 37%).
For example, let’s say you’re married and have a combined taxable income of $150,000. At that income level, you’ll be eligible for the 15% long-term capital gains tax rate, but your regular federal income tax rate will be 22%.
The same $6,000 capital gain we used in the examples above would be subject to a tax of $1,320 – not $900 – if it was the sale of a security you held for one year or less.
Offsetting Capital Gains with Capital Losses
If you sold some losing stock and have a capital loss, don’t feel too bad — you can offset your losses with your capital gains. This is also known as tax-loss harvesting, which is where investors realize capital losses so they can offset their capital gains.
For example, if you have $10,000 in capital gains from the sale of one stock but a loss of $8,000 on another, you can deduct the loss from the gain, giving you a $2,000 net long-term capital gain for the tax year and lowering your capital gains and taxes.
If your capital losses are more than your capital gains, the IRS allows you to deduct up to $3,000 per year in allowable capital losses against non-investment income like wages which can lower your overall taxable income.
If the sale of the stock generating an $8,000 loss occurs in 2020, and you have no gains offset it against, you can deduct $3,000 of that loss against non-investment income for the year.
What happens to the remaining $5,000 in losses? They can be carried forward into subsequent years, and either deducted against future capital gains or written off against non-investment income at a rate of $3,000 per year until the loss has been fully deducted.
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Net Investment Income Tax
Depending on how much you earn, you may face an additional tax. Back in 2013, the IRS implemented the Net Investment Income Tax to partially fund the Affordable Care Act. It imposes an additional tax of 3.8% on investment income if your modified adjusted gross income (MAGI) exceeds certain thresholds.
Those thresholds are as follows:
- Married filing jointly — $250,000
- Married filing separately — $125,000
- Single or head of household — $200,000
- Qualifying widow(er) with a child — $250,000
The tax not only applies to capital gains income, but also investment income derived from interest, dividends, rental and royalty income, and non-qualified annuity income.
Carrying our example above forward, the $6,000 capital gains generated by the sale of stock – which is subject to a $900 long-term capital gains tax, plus any applicable state income tax – may also be subject to the 3.8% NIIT if your income exceeds any of the thresholds above.
*Note, the IRS announced that taxpayers can file a protective claim for credit or refund of net investment income tax related to the Affordable Care Act for tax years 2016 through 2018 based on current litigation. Claims for 2016 needed to be filed by July 15, 2020. Protective claims for 2017 through 2018 should be filed on an amended return and “Protective Claim for refund under California, et al. v. Texas” should be written at the top of your amended 1040-X.
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