In light of the recent stock market plunge, many households across the country are scrambling. Depending on what stage of life you’re in, when you plan on retiring, and how much of your nest egg is stashed away on Wall Street, there’s plenty of time to recoup. Financial analysts are firm in their belief that the steep decline has nothing to do with the current state of the U.S. economy, but rather China’s dire situation.
For long-term investors, the downturn is nothing to be alarmed with. In fact, it may even give you an opportunity to snag a few deals on stocks with attractive futures. However, for those that need to pull out or can’t bear to stay in the market any longer, questions arise. Namely, how do you account for capital gains and losses when selling these financial assets?
What is a Capital Gain?
Despite the sudden plunge, most long-term investors are still in the black. The market has seen steady improvement over the past six years, and this is the first time since early 2009 that Wall Street as a whole has appeared to bottom out. While now is probably a bad time to pull your financial portfolio, some people have no other choice.
If you sell stocks, mutual fund shares, or bonds and earn a profit, tax laws refer to this as a capital gain. In the eyes of the law, there are two very distinct types of capital gains: short-term and long-term. The former come from the sale of assets that were owned for 12 months or less, while the latter come from the sale of assets held in excess of 12 months.
In 2015, there are three different rates for long-term capital gains (depending on which tax bracket you’re in). For those within the 10 or 15 percent tax bracket, the long-term capital gains rate is a pleasant 0 percent. If you’re in the 25, 28, 33, or 35 percent tax bracket, you’ll pay a 15 percent rate on long-term gains. For those in the 39.6 percent tax bracket, the long-term gains rate is an even 20 percent.
As a general rule, short-term capital gains are taxed at standard federal income tax rates.
What is a Capital Loss?
Now, if you’ve only been in the market for a short period of time, the recent plunge probably hurt you a lot more than it did others. If you pull out now, you may find you actually lost money on the sale of your stocks, bonds, or mutual fund shares. In this case, you would take a capital loss.
The silver lining is that you can deduct your capital losses – to an extent. Capital losses are first used to offset any capital gains you had on investments of the same type. In other words, short-term losses offset short-term gains, whereas long-term losses offset long-term gains. Net losses can then be deducted against the other type of gain. If you end the year with a net capital loss, you can deduct as much as $3,000 of the loss against other types of income – including your salary.
Understanding the Holding Period
The key to understanding gains and losses obviously lies in the holding period. After all, there are stark differences between short and long-term gains and losses. “To compute the holding period of a property, you begin counting on the day after the date you acquired the property and stop counting on the day that you dispose of it,” writes Roy Lewis of Fool.com. It’s fairly simple to understand, so don’t make it more complicated than it is.
Don’t Try to Outsmart the System
There’s obviously a lot of strategy that goes into choosing when to sell assets, how to treat gains and losses, and when and where to deduct. Ultimately, you shouldn’t try to outsmart the system, though. Utilize your accountant’s knowledge and make smart choices.