Investments and Taxes

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Many of your returns from investments are treated favorably under the tax law. For example, if you sell a long-term capital asset, such as stock, you may pay less than half as much tax on any gain as you would pay on the same amount of wages. Not only is the capital gain not subject to payroll taxes, but it is taxed at a lower rate than you pay on ordinary income.

To take advantage of the tax benefits for certain investments, you need to understand a few rules.

Length of Time You Hold an Asset

The length of time you hold an asset can make a big difference in how much tax you pay on any gain. If you own a stock for 11 months, for example, you pay ordinary income tax rates on the gain - 25% for many taxpayers.

If you hold that stock a little longer - over the one-year mark - you pay the capital gains rate of 15% instead. (Depending on your income, your capital gains tax rate may be 20%, 15%, or even 0%. High-income taxpayers are subject to an additional 3.8% capital gains tax.)

Wash Sale

Wash sale rules are another case where you need to know the rules - before you sell stocks and buy them back again. In most cases, if you sell capital assets at a loss, you can deduct that loss against other capital gains or, to a limited extent, against ordinary income. If you buy the same stock back within 30 days before or after the sale, you can't take the loss this year. Instead, the loss increases your basis in the new stock.

Knowing the rules can help you make better investment decisions.

For example, say you are comparing an investment that pays dividends to a deposit account that pays interest. If they pay the same rate, it seems like a toss-up - until you consider that qualified dividends on stock you have owned over 60 days are taxed at 15%, or 0% if you are in a lower income tax bracket. Interest is taxed at ordinary income tax rates. That makes the dividend paying investment with a comparable return a better deal after you consider taxes.

Real Estate Rental Property

One investment that has traditionally provided tax benefits is real estate rental property. If you invest in real estate and rent it out, or you convert a former residence to rental property, you probably have many expenses you can deduct against the rental income on your tax return. You can deduct mortgage interest, property taxes, repairs and maintenance, for instance.

You can also deduct depreciation expense to account for loss of value of the building (but not the land) over time. Because depreciation doesn't represent a cash outlay on your part, the depreciation deduction means you could have a tax loss on your real estate rental, even if you do not have a negative cash flow.

If you actively participate in the management of the property, you may be able to use a loss of up to $25,000 from rental real estate to offset your ordinary income, such as wages. Be sure to file jointly if you live with your spouse, otherwise you can't take this deduction. If you lived apart from your spouse the entire year, you may be able to use a loss of up to $12,500.

Employee Stock Options

If your employer offers employee stock options, you may benefit from special tax treatment of these options if you meet the qualifications.

Two kinds of employee stock options receive beneficial tax treatment - incentive stock options (ISOs) and options granted under employee stock purchase plans (ESPPs). Both types of options are statutory stock options.

If you meet the qualifications, you don't pay tax until you actually sell the stock, not when you receive or exercise the option. In addition, you effectively convert a benefit from your employer from ordinary income to a capital gain - so you can use the lower capital gains tax rates.

The holding periods are different for statutory stock options than for most capital assets. To use the preferential capital gains tax rates, you must wait two years from the option grant date, or one year from the exercise date, to sell the stock. Otherwise, part or all of your gain is taxed as ordinary income.


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Upcoming Tax Dates

January 1 — Everyone
Federal Holiday (New Year's Day) - Details

January 11 — Employees who work for tips
If you received $20 or more in tips during December, report them to your employer - Details

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