We get taxed in several different ways, most of which are straightforward types of taxes. Think sales and income taxes. However, one form of taxation confuses many investors. An experienced financial advisor can explain everything you need to know about capital gains taxes.
What is a capital gains tax and how can you take advantage of lower capital gains tax rates?
What is the Capital Gains Tax?
A capital gains tax takes away some of the financial gains you have produced. For example, an investment in a series of government bonds has netted you a financial gain of $10,000. Every year the IRS requires taxpayers to report all capital gains and losses. Just like the federal government wants a slice of your income, it also wants to take a chunk of your capital gains.
It is important to note the IRS does not tax you on capital gains until you sell an investment. Holding on to an investment until the capital tax gains rate declines represents a savvy strategy to limit the amount of money you pay in capital gains taxes.
Limit Your Gains By Factoring in Losses
If you are like virtually every investor, some of your investments generate losses. Although suffering a financial hit appears to be an issue, you can leverage the investment loss by offsetting your capital gains. You view an investment loss as a type of tax asset that you subtract from the aggregate value of your investment gains. This is an especially effective strategy when capital gains taxes are high.
The More You Earn, the More You Pay in Capital Gains Taxes
Married couples can file a joint claim that allows them to shelter no more than $80,000 of income from the capital gains tax. You must pay income tax, but you have up to $80,000 of your capital gains free of taxation. Married couples that file jointly also benefit from a lower capital gains tax rate if their incomes fall between $80,000 and $500,00.
Invest in a Tax-Deferred Retirement Plan
When you invest in assets placed in a retirement plan, the federal government cannot touch that money until you reach retirement age. The primary benefit of waiting to have your capital gains taxed is to take advantage of the compounding effect, in which you generate more money because the value of your assets increases throughout the years.
Leave Assets That Have Appreciated to Beneficiaries
Another savvy financial maneuver to lower your capital gains tax rate involves setting up some type of estate plan. Creating an estate allows you to pass on assets that have gained in value to your beneficiaries. Your beneficiaries do not pay taxes on the appreciated assets until they start taking the assets out of the estate plan.
If you plan to liquidate investments worth a substantial amount of money, you should first contact a certified financial advisor to help you make the most prudent decisions concerning the capital gains tax. An expert in the capital gains tax can educate you on how to take advantage of lower capital gains tax rates.