December 2022
Tax Planning

Tax Tip - How to Reconcile Capital Gains and Losses?

We know when preparing our taxes for the year we must net out our capital gains and losses, but not all gains and losses are created equal. Do you know how the netting process works?

First, let’s understand the terminology.  The terms short-term and long-term apply to asset ownership periods.  If you hold an asset for more than 1 year before you sell it, the gain or loss is considered long-term.  If you hold an asset for 1 year or less, the gain or loss is considered short-term.   This is important because short and long-term gains and losses are taxed differently and will ultimately impact your tax liability. 

Long-term gains (LTG) are netted out separately from short-term gains (STG). Let’s say that this year you sold two positions that you held for more than a year (making them long term), one for a $1,000 gain and the other for a $400 loss. You would subtract the $400 loss from the $1,000 gain, giving you a total LTG of $600.

Short -term gains are netted separately from LTG.  Now let’s say that you also sell two positions that you held for less than a year, one for a $300 STL and the other for a $100 STG.  When you net these two out, you have a $200 STL.

This leaves us with a $600 LTG and a $200 STL that nets out to a $400 LTG. Depending on your taxable income for the year, you would pay tax of either 0%, 15%, or 20% on the $400 LTG.

Everything comes down to four situations:

• Long-term gain with short-term gain

• Long-term loss with short-term gain

• Long-term gain with short-term loss

• Long-term loss with short-term loss

Long-term gain with short-term gain

As mentioned above, based on your taxable income, long-term gains receive preferential tax treatment at rates of 0%, 15%, or 20%.  Short-term gains are taxed as ordinary income.

Long-term loss with short-term gain

In this situation, it would depend on which is larger, the loss or the gain. If your gain is larger than your loss, then you have a net short-term gain. As mentioned above, the short-term gain is taxed as ordinary income. If your loss is larger than your gain, then you would have a net long-term loss. A max of $3,000 in losses is allowed to be used to offset other kinds of income. Any unused long-term losses will be carried forward to following years until they are used up.

Long-term gain with short-term loss

This would also depend on which is larger. If the gain is larger than the loss, you will end up with a net long-term gain and will be taxed at the preferential tax rate depending on your taxable income for the year. If your loss is larger than your gain, then it’s a net short-term loss. As mentioned above, $3,000 may be used against other types of income, with any unused short-term losses being carried to future years.

Long-term loss with short-term loss

While this seems self-explanatory, there is a catch. We know we can use up to $3,000 of losses in a year to offset ordinary income, so if total losses are less than $3,000, we’re done. If losses are more than $3,000, some may be carried over to the following years. The loss that can be carried over can be long-term or a combination of long- and short-term, but never just short term.   Why? Because short-term losses must be used first.

If you have questions or concerns as to how the gains and losses in your taxable accounts can affect your personal tax situation, feel free to reach out to schedule a meeting with your advisor. We have tax-planning software that will help us determine your potential tax liability under a variety of scenarios. 

If you have questions, please contact us.

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