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Building wealth is important, but so is keeping it too. When preserving wealth, many high-net-worth investors often leverage a particular tax benefit: preferential capital gains tax rates. These preferential rates allow them to keep more of their wealth intact. But here’s the good news: these rates aren’t exclusive to the ultra-wealthy. You can take advantage of them too. Let’s dive into everything you need to know.
A capital gain occurs when you sell an asset for more than you paid, resulting in a profit. This profit is subject to tax, and the assets in question can include:
Understanding the tax implications of these gains is crucial to enhancing net returns of taxable assets. Capital gains are taxed differently depending on how long you've held the asset.
There are two main types of capital gains rates:
To understand the impact that long-term capital gain rates can make, first check out the federal income brackets of ordinary income:
Long-term capital gains are taxed separately from ordinary income taxes. Here’s how the federal rates break down for 2024:
With these rates, it’s easy to see where the tax savings come from, especially amongst high-income earners. An important note is that the ranges in the capital gains rates are based on taxable income, including capital gains AND income.
Keep in mind that we are talking about federal rates in these ranges. States have different rules regarding capital gains. For simplicity, we will focus these examples on the federal level.
Let’s take a closer look at how these rates work in practice.
Example 1: Suppose you're a single filer in 2024 with an annual income of $200,000, and you made $30,000 in short-term capital gains (STCG). Since STCG is taxed as ordinary income and your total taxable income would be $230,000, the $30,000 would be taxed at the marginal tax rate, which could be 32%.
Now, if that same $30,000 gain were a long-term capital gain (LTCG), it would be taxed at the capital gains rate of 15%. Even though your total taxable income is still $230,000, the $30,000 is now taxed according to the capital gains brackets instead:
As you can see, the savings are significant (more than half in this case!).
Here are a couple more examples of how this is treated.
Example 2: Single, $30,000 Income, $10,000 LTCG
But what happens if your capital gains are larger?
Example 3: Single, $30,000 Income, $20,000 LTCG
In this case, the total long-term capital gains taxes are $446.25. However, as you can see, the capital gains rates are based on the total income earned together, and the capital gains are added on top.
This is why integrating assets with capital gains treatment with ordinary income can help reduce your tax bill!
Utilizing capital gains can substantially lower your tax liability, but what happens when you realize a loss? You can use these losses to offset any gains that you incur.
Here are a couple of quick examples to show this:
The ability to move positions in your portfolio while taking advantage of losses to minimize realizing taxes is also known as tax loss harvesting.
The illustration below shows another example of combining long-term capital and short-term gains/losses. The larger of the two in the end carries the title long or short:
If you end up with a total net loss, you can deduct up to $3,000 as an "above-the-line" deduction in that tax year (Note: This is slightly different if you are married and filing separately). Any excess loss is carried over to the next tax year, helping to reduce your taxable income in future years.
For example:
Understanding capital gains and how they’re taxed is a powerful tool for managing your investments and reducing your tax liability. Whether you’re a high-income earner or just starting, these preferential rates can help you keep more of your hard-earned money. Remember, smart investing isn’t just about making money—it’s also about keeping it.
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