For the first time in about five years, people are saying positive things about the stock market.
With all of the major indexes showing year-to-date gains of 20+ percent, your investment portfolio may be looking better than it has in quite some time. And you may be thinking about selling some of your stocks to lock in those gains.
Before you sell, consider the tax consequences. For stocks held in a qualified retirement plan, there are no taxes paid on the sale. Depending on the type of plan, you may have to pay tax when you receive distributions.
For stocks you hold in a taxable account, the sale generally results in a capital gain or loss. If your capital gains for the year exceed your capital losses, the excess is taxable.
The amount of tax you pay depends upon whether your net gain is long-term, short-term or a combination of the two. Whether a gain is long- or short-term is determined by your holding period in the stock sold. Generally, the holding period begins when you buy the stock and ends when you sell it. Special rules apply for stocks acquired through gift or inheritance.
If the holding period is greater than one year, the gain (or loss) is long-term. If the holding period is one year or less, the gain (or loss) is short-term.
A net short-term capital gain is taxed like any other ordinary income. You pay tax at your regular marginal tax rate. Net long-term capital gains are taxed at a lower rate.
The maximum tax rate on long-term capital gains depends on your marginal tax bracket:
- A tax rate of 20 percent applies to your long-term capital gains if you are in the 39.6 percent marginal tax bracket.
- A tax rate of 15 percent applies to your long-term capital gains if you are in a 25, 28, 33 or 35 percent marginal tax bracket.
- A tax rate of zero percent applies to your long-term capital gains if you are in a 10 or 15 percent marginal tax bracket.
Whether the net gain is short- or long-term, if your modified adjusted gross income and your net investment income exceed $250,000 (for married filing jointly taxpayers), an additional 3.8 percent tax rate will apply.
Since long-term capital gains enjoy a lower tax rate than short-term capital gains, it’s a good idea to check your holding period before harvesting gains in your taxable investment accounts. If you’re still in a short-term position, you will have a challenging decision to make.
If you hold onto the position until the gain becomes long-term, the market may turn against you. The gain may be reduced or may evaporate entirely.
Check with your investment advisor as well as your tax advisor when making decisions on when to sell your investments.