Hi, I’m Bette Hochberger, CPA, CGMA. Today I will be discussing taxes on investments and what you need to know to reduce your tax bill.

 Investing can help you become wealthy and financially secure, but you also need to be careful about taxes. If you don’t understand how and when taxes apply to your investments, it could end up costing you a lot of money. So, it’s important to pay attention and learn about taxes so that you can make the most of your investments. 

Here are five types of taxes that commonly apply to investments, along with tips on how you can reduce the amount you owe.

Tax On Capital Gains

When you invest, you hope to make a profit when you sell your assets like stocks or property. These profits, known as capital gains, are generally taxable. But don’t worry, there are ways to minimize your tax bill!

Basically, the longer you hold an asset before selling it, the lower your tax rate will be. If you held it for over a year, your tax rate can be as low as 0%. However, if you sell an asset you held for less than a year, your tax rate will be the same as your regular income tax rate.

But here’s a pro tip: you can use investment losses to offset your gains and lower your taxes. This is called tax-loss harvesting, and it’s a smart strategy to keep more money in your pocket. 

For example, if you sold one stock for a $10,000 profit and another at a $4,000 loss, you’ll only pay taxes on the $6,000 gain. So, make sure you’re aware of the rules around capital gains taxes and use strategies like tax-loss harvesting to help you keep more of your hard-earned money!

Tax On Dividends

When it comes to investing, dividends are a great way to earn income from your stocks. But did you know that they’re usually taxable? Even if you automatically reinvest your dividends to buy more shares, you still need to report them as income.

There are two types of dividends: nonqualified and qualified. Nonqualified dividends are taxed at the same rate as your regular income tax bracket. But qualified dividends are usually taxed at a lower rate of 0%, 15%, or 20%, depending on your taxable income and filing status.

To minimize your tax bill, consider holding onto your investments for a certain period of time to qualify for the lower tax rate. Make sure to set aside some cash for taxes on dividend payments to avoid a surprise bill come tax time. Another option is to hold dividend-paying investments in a retirement account, which can help defer taxes on your investments. 

Taxes On Investments In a 401(k)

A 401(k) can be a great option if you’re looking to save for retirement. With a traditional 401(k), you don’t pay taxes on the money you contribute or on investment gains, interest, or dividends while the money is in the account. Instead, taxes are only assessed when you make a withdrawal.

With a Roth 401(k), you pay taxes upfront, but then qualified distributions in retirement are tax-free. If you withdraw money from a traditional 401(k) before age 59½, you may have to pay a 10% penalty on top of the taxes (unless you qualify for an exception). And if you wait too long to make withdrawals (after age 72), you may also face a penalty. 

If you need to withdraw money from your account before you’re 59½, check if you qualify for an exception to the penalty. Another option is tax-loss harvesting, as I mentioned above. You can also borrow from your account instead of withdrawing or rolling over the account to reduce taxes.

Tax On Mutual Funds

Mutual fund taxes are a reality for investors, encompassing taxes on dividends and capital gains while holding the fund shares and taxes on capital gains when selling the fund shares. The mutual fund generates and distributes dividends, interest, or capital gains from the investments inside, resulting in taxes that need to be paid, even if no shares have been sold or cash received. 

The tax rate varies based on the distribution type and other factors. Selling shares for a profit incurs capital gains tax. To minimize these taxes, waiting at least a year to sell shares can reduce the capital gains tax rate. Holding mutual fund shares within a retirement account defers tax on interest, dividends, or gains. Tax-loss harvesting and choosing funds that distribute less taxable income are also options to explore.

Tax On The Sale Of a House

Selling your home for a profit may trigger taxes, but the IRS allows an exclusion of up to $250,000 for singles and $500,000 for married couples filing jointly.

 For instance, if you bought a home for $200,000 and sold it for $800,000, you might exclude $500,000 of the gain from taxes, but the remaining $100,000 could be taxed based on your income and tax-filing status. 

To minimize taxes, review the exclusion criteria and exceptions carefully and consider the value of home improvements you’ve made.

Well, I hope you learned something new today. As always, stay safe, and I will see you next time.