Lower Your Taxes with Capital Gains
So what are Capital Gains?
When you sell an asset for more than you paid for it, your profits are considered capital gains.
This is a different type of income than what your regular job pays, which would be considered earned income.
A crucial difference between these two types of income is how they are taxed, and capital gains have a much more favorable tax treatment.
How are Capital Gains Taxed?
In two ways, depending on how the gain was earned. If you sold the asset without owning it for a year you are on the hook for short-term capital gains which are taxed at your normal tax rate, easily somewhere in the 20-30% range.
If you held onto the asset for more than 12 months, your profits are considered long-term capital gains and given preferable tax treatment.
In 2022, if you make up to $41,675 a year, you pay 0% on long-term capital gains.
If you make up to $459,750 a year, you pay 15% tax on long-term capital gains.
And if you make more than $459,750 a year, you pay a 20% tax on capital gains.
How does this affect my taxes?
Let's use an example. An investor buys $10,000 worth of stocks and sells them for $20,000 in 6 months. This means they made $10,000 in profit and it's considered short-term capital gains. If the investor has a $90k salary they are in the 24% federal tax bracket and would owe 24% of their $10,000 gain in taxes. Leaving them with $7,600 at the end of the day.
If the same investor were to hold on to those stocks and sell them after a year, things would change.
The investor sells their stock for a $10,000 profit after 12 months, so their profits are considered long-term capital gains. Based on their tax bracket, they would owe 15% which would leave them with $8,500 after taxes. That's $900 more in profit (+11.8%) than taking short-term capital gains.
Capitals gains let investors profit in a tax-advantaged way, which can leave you with a much smaller tax bill than the earned income you get from your job. It's another way the wealthy get wealthier, but it's also a strategy that any investor (including you) can and should consider.
By the way, I'm not a financial professional and none of this should be considered financial advice. Please consult with your financial advisor when considering any suggestions or ideas I've shared.