As we get closer to the April 15 tax-filing deadline, you may be wondering about how your actions can affect the amount of taxes you pay. Of course, you don’t have total command of some key tax-related components, such as your earned income. But one area in which you do have a degree of control is your investment-related taxes. And since 2014 was a decent year for the financial markets, you may have some gains. If you decide to sell some of your investments to “lock in” those gains, what would be the tax consequences?
Essentially, the answer depends on two variables: your tax bracket and how long you’ve held the investments.
Our tax code rewards those investors who hold their investments for longer than one year. Consequently, short-term capital gains — earned on investments held for less than one year before being sold for a profit — are taxed at an individual’s ordinary income tax rate, which for 2014 can be as high as 39.6%. However, long-term capital gains, earned on investments held one year or longer, are taxed at just 15% for most taxpayers and 20% for those in the 39.6% bracket. (At this tax bracket, a 3.8% Medicare contribution tax may also apply to long-term gains, so the top capital gains rate would be 23.8%.) You’ll need to check with your tax advisor on your specific situation.
From a tax standpoint, you may be better off by keeping your profitable investments at least one year before selling them. But are there also other reasons to hold investments for the long term?
In a word, yes. For one thing, if you are constantly buying and selling investments, you won’t just incur taxes — you’ll also rack up commissions and fees that can eat into your investments’ real rate of return.
Also, if you are always buying and selling, you may be doing so for the wrong reasons. You might be chasing after “hot” investments, even though by the time you buy them, they may already be cooling off — and, in any case, they may not even be right for your needs. Or you might decide you need to “shake things up” in your portfolio because you haven’t liked what you’ve seen on your investment statements for a particular time stretch. But if the overall market is down, it tends to drag everything down with it — even quality vehicles that still have good prospects.
Rather than chasing after hot stocks or reacting to short-term price movements, you may be better off by following a “buy-and-hold” strategy in which you purchase investments appropriate for your needs and then hold those investments for the long term. Of course, “buy and hold” does not mean “buy and forget.” You may still need to make transactions, but only if it’s really necessary — such as when an investment is no longer appropriate for your investment goals.
If you want to cut down on your capital gains taxes, holding quality investments for the long term makes sense. As for an investment strategy, a buy-and-hold approach can work well for you — long after tax season has ended.