Capital Gains - Noteworthy Insights for Investors

When an investment increases in value, the growth is certainly something to celebrate. But eventually selling an appreciated investment can also create an important tax consideration—capital gains. Our focus this week explores key considerations related to capital gains.

What Do We Mean By The Term "Capital Gain"?

A capital gain generally occurs when you sell a capital asset for more than your adjusted cost basis. Capital assets can include stocks, bonds, mutual funds, real estate, and many other investments.

Your cost basis is generally what you originally paid for an investment, although certain purchases, reinvestments, improvements, and other events can adjust that number over time.

Here's a Simple Example:

You purchase an investment for $20,000 and later sell it for $30,000.

• Sale Price: $30,000
• Cost Basis: $20,000
• Capital Gain: $10,000

Importantly, the entire $30,000 isn't your gain. Generally, it is the $10,000 difference that represents your capital gain.

How Long You Own an Investment Matters

Not all capital gains receive the same federal tax treatment.

Short-term capital gains generally apply to investments held for one year or less. These gains are generally taxed at ordinary income tax rates.

Long-term capital gains generally apply to investments held for more than one year. A lower federal tax rate may apply to net long-term capital gains, depending on the taxpayer's circumstances and taxable income.

Why It Matters
Before selling an appreciated investment, it can be worthwhile to check the original purchase date. In some situations, waiting until an investment qualifies for long-term treatment can produce a different tax result. Taxes shouldn't necessarily dictate an investment decision, but they should be one of the factors considered.

Capital Losses Can Help Offset Capital Gains

Not every investment goes up in value. Fortunately, investment losses can sometimes provide a tax benefit.

When investments are sold at a loss, those capital losses can generally be used to offset capital gains. If total capital losses exceed total capital gains, individuals may generally deduct up to $3,000 of net capital losses against other income each year ($1,500 for married individuals filing separately). Remaining eligible losses can generally be carried forward to future tax years.

This is one reason investors sometimes use a strategy known as tax-loss harvesting—strategically realizing certain investment losses to help offset realized gains elsewhere in a portfolio.

*Any tax-loss harvesting strategy should be evaluated carefully, including applicable tax rules, before transactions are made.

Step-Up in Cost Basis - Important Estate Planning Consideration

One of the most important—and sometimes overlooked—concepts surrounding capital gains involves inherited assets and the step-up in cost basis.

Under current federal tax rules, the basis of property inherited from a deceased individual is generally adjusted to its fair market value on the date of death, subject to certain exceptions and special rules.

Here's a Simple Example:

Suppose a parent purchased stock many years ago for $50,000. Over time, the stock grows to $200,000. If the parent sells the investment during their lifetime for $200,000, there could generally be a $150,000 capital gain before considering other adjustments or tax factors.

However, assume that the parent continues to own the stock until death and the investment is inherited when it is worth $200,000. The beneficiary's new cost basis would generally be approximately $200,000, assuming $200,000 is the applicable fair market value for basis purposes. If the beneficiary subsequently sells the investment for $205,000, the capital gain would generally be approximately $5,000 rather than $155,000.

That difference illustrates why cost basis should be part of conversations about estate and legacy planning. There is another important distinction: gifting appreciated property during your lifetime generally does not produce the same basis result as leaving property through an estate. Gifted property generally carries over the donor's basis for purposes of determining gain, subject to special rules.

Planning Takeaway: Before gifting or selling a highly appreciated asset, investors may want to discuss the potential income-tax and estate-planning consequences with their financial and tax professionals.

Closing Thoughts

Capital gains are a good challenge to have—as they represent an investment which has increased in value. But understanding cost basis, holding periods, capital losses, and the treatment of inherited assets can help investors make better-informed decisions about what they own and when they sell or pass along assets.

At Lighthouse Wealth Partners, we believe investment management does not exist in a vacuum. Tax considerations, retirement planning, estate planning, and portfolio strategy can all overlap. Prior to making a significant sale, gift, or transfer of an appreciated investment, we encourage clients to consider how the decision or strategy fits into their broader financial picture. As always, we are happy to help guide and empower you along your financial journey.