This article is meant to explain the basics of how one may be taxed on capital gains from investments, and look at how it differs depending on which type of account they have invested in. For almost all types of investment, two kinds of taxation apply:
1) Withdrawal tax
Whenever a withdrawal(s) is made from an investment before the investment reaches maturity, you will have to pay a percentage of your profit as tax. This can happen if you sell off some or all of your position, or if the bank automatically withdraws a portion of your profit for you due to compounding interest.
The latter case can be avoided by keeping a small amount in whatever form your savings is kept so that the bank doesn’t automatically withdraw anything. This is important because it will affect how much you owe in taxes every year.
2) Reinvestment tax
When you reinvest your profit to purchase additional units of whatever asset it may be, there’s a chance that you will have to pay tax on the new investment(s). This can happen if one reinvests their dividends or interest into purchasing more stock, or reinvests their capital gains back into purchasing more real estate.
The keyword here is “purchase”, as opposed to “sell” – if your initial investment were from money that was gifted to you, then the reinvested amount would not be as a “gain”, and would not be taxable. The same goes for inheritances in most cases, in which case they are also not counted as capital gains.
Another time in which the reinvestment of capital gains is not taxable is if it were to be used on an Individual Retirement Account (IRA), or another form of retirement account.
If you want to avoid reinvesting your capital gains and paying tax on them, you should hold off from any real estate investments until such a time where you may need the additional cash.
This will help keep your taxes down by avoiding reinvestment. Selling off some shares once every year or two could also help avoid this problem, but there’s no guarantee that the price for each share will be the same during your next purchase.
You will have to pay tax on capital gains regardless of whether or not you reinvest them, but there are some cases in which one may be able to avoid this by picking their times wisely. You typically cannot avoid paying taxes for shares that are sold off, but if you do it at the right time then you can save yourself money on taxes.
The keyword here is “time” because timing issues can affect how much profit one makes (or loses), and thus how much one will owe in taxes.
One simple example would be during a recession when many people choose to sell off their losing investments instead of waiting for them to mature and reach maturity value. The loss from selling it at that point (or near that point) can claim a tax deduction, which is applicable whether it’s realized as a short-term loss or long-term loss.
Selling an investment again during times of recession can also help save on taxes, because another person may need to buy those shares so you don’t have to hold onto them until they mature.
The bottom line is this: One should be wary about when they choose to act with their investments, so as not to be taxed under the wrong circumstances. If one is reinvesting, then they should try doing it after having read various sources about how the economy will look in the coming months and years.
For capital gains that are realized, they should try doing it during a recession to save on taxes or avoid selling at all if they have a large enough amount of overall investments. Choosing the right times for each one is crucial – time can help you contact wealth.
Do you have to pay capital gains if you reinvest? To know more, just click on the underlined words.