Capital gains taxes

Introduction

Capital gains taxes are taxes on gains made on your investments. These taxes are incurred when the gains are “realized” by the investor. For most people, this will be when a stock holding is sold.

For instance, if I bought a single share of VTSAX at $70, then sold it for $75 at a later date, I realized $5 in capital gains. Another example of capital gains is the sale of real estate. I am by no means an expert on how or when these capital gains apply, but it is something to be aware of!

The wealth that I, the shareholder/homeowner, garnered from this transaction has not yet been taxed. Therefore, the IRS implemented capital gains taxes.

Capital losses

Capital losses are just negative gains! They do also have tax implications. Capital losses can be used to offset capital gains of the same treatment (i.e. long term offsets long term). Short term capital losses can also be used to offset ordinary income up to $3,000 and the remainder can be carried over to future tax years. This is useful for tax loss harvesting.

Tax rate

There are generally two types of capital gains: short term capital gains, and long term capital gains. The IRS penalizes short term capital gains to avoid “quick gain” type transactions such as day trading and speculation. It does so by taxing short term capital gains as income, meaning your top marginal tax bracket (thus a higher tax burden for such types of gains).

With long term capital gains, you are taxed at one of the following brackets: 0%, 15%, 20%. The current brackets are set as the following:

Rate	Single	Married filing jointly	Married filing separately	Head of household
0%	$0-$44,625	$0-$89,250	$0-$44,625	$0-$59,750
15%	$44,626-$492,300	$89,251-$553,850	$44,626-$276,900	$59,751-$523,050
20%	$492,301+	$553,851+	$276,901+	$523,051+

How this plays into retirement

At the moment, the taxation of long term capital gains is extremely advantageous. It's a little subtle to pick up on, but these are just on the gains alone. That means the above tax rates are applying to only a portion of the actual sale of the asset.

Let's take an example:

I have $150,000 in VTSAX, with a cost basis of $100,000. This amounts to $150,000 of wealth, and $50,000 of capital gains. If the sale of all shares of VTSAX was the only income that I had for the year (married filing jointly), my tax rate would be a whopping...0%. In fact, it would be negative due to the standard deduction.

 I will have realized $50,000 of capital gains, fallen squarely under the 0% tax bracket, and been able to take the standard deduction of $27,700 and had a whopping total of $177,700 to spend.

Pair this with investment vehicles like Roth IRAs and HSAs which have pre-tax withdrawals, you can start to see how your tax picture could be much smaller than you think in retirement!

This detail is also important to keep in mind, as you can potentially leverage the tax space to do capital gain harvesting.