Capital Gains: What Strategies Offer You the Best Chance of Good Returns?

The capital gains tax is a levy on the amount of profit that any investor can make through the selling of investments. The tax year that investments are sold is when the tax on that investment is due. There are two types of capital gains tax: long-term and short-term. Long-term capital gains tax rates are calculated based on the income of the person paying the tax. This can either be 0%, 15% or 20%, and income brackets are adjusted every year. Long-term capital gains tax will be owed on any profits of investments that are owed for one year or more. Any investments that have been owned for less than one year are subject to short-term capital gains tax. This is usually significantly more expensive and is determined by the ordinary income bracket of the taxpayer in question. This provides investors with the incentive to keep a hold of their investments for more than one year since the tax on any profit made will therefore be lower. You should note that the President has recently proposed the raising of long-term capital gains taxes for anyone who is earning $1 million annually or more to a tax rate of 39.6%. This will be combined with the existing surtax that is applied to high-income investors of 3.8%, meaning that the tax rates for high-income investors could get as high as 43.4% nationwide.

To help you make the most of your investment profits, here are some tax strategies that will offer you the best chance of getting good returns on your investments:

It’s all in the timing

Holding onto your assets and investments for longer reduces the amount of tax you need to pay. The tax on any assets that have been held for over one year is vastly reduced, so you will have to pay less. This can be used to your advantage, although if you are a day trader who focuses on making lots of quick turnover trades you will be liable to pay significantly higher rates of tax on your profits.

Make use of the annual exemptions for capital gains. In the US, there are different rates of capital gains tax depending on the tax bracket you are in, and this includes the annual exemption amounts. The tax year in which you make a sale is when the capital gains tax on that investment is due, which can be used to your advantage if you plan your sales properly. You can cash in on this if you’re going to be making a big sale by selling in two different shares which are in different tax years, to maximize on the annual exemptions of two different years. Alternatively, you can make smaller partial withdrawals every year and try to stay as close to your annual exemptions as possible, rather than making one huge withdrawal that will be taxed heavily.

Take advantage of your capital losses

Your capital losses can be used to offset capital gains, and therefore lower the tax you have to pay on capital gains each year. If your losses are greater than your gains, you can claim up to $3,000 against your income. This can be transferred forward into future years for as long as necessary, so if you have an $18,000 loss one year you could effectively claim the $3,000 losses every year for the next 6 years.

Invest in IPO stock

If you’re looking to invest in the stock market, a great strategy for maximizing your Capital Gains returns is to buy your stocks at IPO. When a company is looking for capital, it will often release shares at an initial public offering, or IPO. Buying a stock at IPO price can be difficult as there are many regulations on who can and can’t buy them, however, if you can get your hands on them they could prove to be extremely valuable. Buying IPO stock is a fast process and can lead to incredible gains, but also huge losses. This is an extremely volatile form of investing, but if it pays off it can pay off big.

Participate in a retirement plan

Common retirement plans such as 401ks or an IRA are able to grow your investments over time without subjecting this money to capital gains tax. However, be aware that any withdrawals from these plans are taxed just like regular income, so only withdraw from plans like this if you really need to.

Organize your shares

Investors tend to use one of 5 basic methods to organize the buying and selling of their shares. These are:

• First in, first-out (FIFO) - the first assets that are acquired are the first to be disposed of

• Last in, first-out (LIFO) - the last assets to be acquired are the first to be disposed of

• Dollar value LIFO - similar to a regular LIFO, but figures are all in dollar amounts instead of being in inventory units

• Average cost - uses a weighted average of inventory that was purchased in a particular period to value any goods

• Specific share identification - the optimization of tax treatment when someone is selling off holdings which offers flexibility but requires incredible precision.

The best choice for you will depend on how you most commonly trade, the prices of shares or the amount of gain that may be declared on any one trade. If you’re finding it difficult to work out, talk to a tax adviser or some other financial professional to help you to understand the best method for you.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.