Capital Idea! Capital Gains, Losses, and Tax Consequences

We live in a world of taxes. Some taxes are obvious and affect most people: income or sales taxes, for example. Some taxes, however, are more specific and targeted in scope, yet they can be quite consequential. The best example of such a tax? The capital gains tax. What is it, and how might it affect your tax liability?

The term capital gain refers to the increase in the value of a capital asset when it is sold. Put simply, a capital gain occurs when you sell an asset for more than what you originally paid for it. Almost any type of asset you own is a capital asset. This can include a type of investment (like a stock, bond, or real estate) or something purchased for personal use (like furniture or a boat).

It is important to note how a taxable gain is only triggered when an appreciated capital gain is realized, i.e., sold at a price higher than its original purchase price. In other words, do you owe taxes if you bought a stock five years ago at $15 a share and the same share is now worth $40? Nope. Not yet. Not until you realize the $25 capital gain, i.e. you sell the share for $40. Until you sell, the $25 gain is referred to as paper gains, existing only on paper until actually sold. If you own stock that goes up in price but haven't yet sold it, that is an unrealized capital gain.

How long you wait before realizing your gains will also affect your taxes. Short- and long-term capital gains are taxed differently. Remember, short-term gains occur on assets held for one year or less and are taxed at ordinary income rates.

You buy something, you hold it, it grows in value, you sell it, you pay taxes on the gain. Fairly straightforward. But the sale of what kind of assets commonly triggers a capital gains tax? Let’s start with two assets that are exceptions to this rule. Many people have two assets that usually grow in value and yet do not trigger a capital gains tax when sold: 401(k)/IRA investments and a primary residence.

401(k) and IRA investments are held in pre-tax qualified accounts. Yes, these investments are generally sold at a gain, and taxes need to be paid. But the investments held in these qualified retirement accounts were purchased with pre-tax dollars, meaning that they are subject to regular income tax rates once withdrawn from (not sold within) the account.

The selling of your primary home might be subject to capital gains tax, but often to a lesser degree than usual, and possibly not at all. If you have lived in your house for at least two years, the first $250,000 is exempt from capital gains tax when you sell your primary home. That figure doubles to $500,000 for married couples.

For most people, capital gains taxes are usually minimal or nonexistent. However, capital gains taxes are often triggered in taxable brokerage accounts where they do exist. In other words, selling appreciated assets like stocks, bonds, ETFs, mutual funds in an account that is not a 401(k), 403(b), IRA, etc. will usually trigger a taxable event that needs to be accounted for when you file taxes. Additionally, realizing a capital gain that is large in comparison to the rest of your income could trigger alternative minimum tax (AMT), so if you're planning to sell investments that have large capital gains, you may want to talk with a tax advisor first to make sure you understand how this will impact your taxes.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice. Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s client.