When Do You Have to Pay Capital Gains?

Regardless of where you are in your investing journey, it’s important to understand capital gains and what they mean for your accounts, when you have to pay them, and how this all shakes out at tax time.

A capital gain occurs when you sell an investment for more than your cost basis (the cost at which you purchased it).  There are two types of capital gains: short term capital gains and long term capital gains.  As you can probably guess, the type of capital gain depends on how long you kept the investment.  If you kept the investment for longer than 12 months, it is a long term capital gain.  Any holding period less than that is considered short term (including buying the investment January 1 and selling it December 31 of the same year, for example).  No matter what, the government wants a slice of that pie, so you can’t escape paying tax on either type of capital gain.  However, you are rewarded for long term investing with a lower tax rate on long term capital gains. 

The gains can also be classified as either unrealized or realized gains.  Unrealized gains is a fancy term for noticing that your stock fluctuated upwards when you logged onto your investment website.  You may hear a friend bragging about “making $700 on XYZ stock today,” but if they did not actually sell the stock (aka. realize the gains), they didn’t “make” diddly squat.  You’re not going to realize this gain or get taxed on it unless you sell it. 

One of the big things to look out for – especially if you are doing your own investing – is short term capital gains taxes.  As I mentioned before, Uncle Sam is more interested in those short term capital gains taxes and will charge a higher tax rate on them (up to 37% in 2020!!!).  If you’re day-trading like crazy and enjoying playing the stock market, be extra aware of short term capital gains taxes and the higher tax rate you’re going to be responsible for paying next tax season.

Besides investing for the long term, another way to lessen the blow of capital gains tax is to invest in a qualified retirement account (like a Traditional IRA, 401(k), etc.) because the tax is deferred in these types of accounts anyway.  You will still have to pay tax on ordinary income when you remove money from this account in the future, but it will generally be at a lower tax rate.

I’m happy to discuss an investment strategy with you or answer any questions about short or long term capital gains!  Please complete the contact form for a complimentary consultation.

This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor.  Kerrigan Financial Management and LPL Financial do not provide tax advice or services.