11.1 Capital Gains & Investment Taxes

Understanding tax implications is essential for making suitable investment recommendations. Tax efficiency can significantly impact after-tax returns and should be integrated into portfolio management strategies.

Capital Gains Basics

A capital gain occurs when you sell an asset for more than your cost basis (generally, purchase price plus improvements or adjustments).

Short-Term Capital Gains

- Holding Period: 1 year or less

- Tax Treatment: Taxed as ordinary income

- Tax Rates: 10%, 12%, 22%, 24%, 32%, 35%, or 37%

- Planning Note: No preferential treatment

Long-Term Capital Gains

- Holding Period: More than 1 year (at least 1 year + 1 day)

- Tax Treatment: Preferential rates

- Tax Rates: 0%, 15%, or 20%

- Planning Note: Hold investments over 1 year when possible

2026 Long-Term Capital Gains Brackets

- Single: 0% Rate Up to $49,450; 15% Rate $49,451 - $545,500; 20% Rate Over $545,500

- Married Filing Jointly: 0% Rate Up to $98,900; 15% Rate $98,901 - $613,700; 20% Rate Over $613,700

- Head of Household: 0% Rate Up to $66,200; 15% Rate $66,201 - $579,600; 20% Rate Over $579,600

Special Capital Gains Rates

- Collectibles (art, coins, antiques): Maximum Rate 28%

- Section 1202 QSBS (qualified small business stock): Maximum Rate 28%

- Unrecaptured Section 1250 (depreciation on real estate): Maximum Rate 25%

Net Investment Income Tax (NIIT)

An additional 3.8% tax applies to the lesser of:

- Net investment income, OR

- MAGI above threshold

- Single: MAGI Threshold $200,000

- Married Filing Jointly: MAGI Threshold $250,000

- Married Filing Separately: MAGI Threshold $125,000

Maximum Effective Rate:

Maximum Rate = 20% + 3.8% = 23.8%

This applies to the highest earners.

Dividend Taxation

Qualified Dividends

Taxed at long-term capital gains rates (0%, 15%, or 20%)

Requirements:

- Holding period: More than 60 days during 121-day period around ex-dividend date

- Paid by U.S. corporation or qualified foreign corporation

Most common stock dividends qualify.

Non-Qualified (Ordinary) Dividends

Taxed as ordinary income (up to 37%)

Examples:

- REIT dividends (generally)

- Money market dividends

- Dividends from stocks held short-term

- Short sales dividends

Tax Loss Harvesting

Strategy

Sell investments at a loss to offset capital gains or ordinary income.

Rules:

- Capital losses first offset capital gains

- Excess losses offset up to $3,000 of ordinary income ($1,500 if married filing separately)

- Unused losses carry forward indefinitely

Order of Netting

1. Short-term gains vs. short-term losses

2. Long-term gains vs. long-term losses

3. Net short-term vs. net long-term

4. Excess losses lead to $3,000 ordinary income offset

Example:

- $10,000 long-term gain

- $15,000 long-term loss

- Net = $5,000 loss

- $3,000 offsets ordinary income

- $2,000 carries forward

Wash Sale Rule

Definition

Cannot claim a loss if you purchase substantially identical securities:

- 30 days before the sale, OR

- 30 days after the sale

Total window: 61 days (30 + sale day + 30)

What Triggers a Wash Sale / Does NOT Trigger

- Triggers: Buying same stock; Does NOT Trigger: Buying different stock in same industry

- Triggers: Spouse buys same stock; Does NOT Trigger: Buying different company's stock

- Triggers: Your IRA buys same stock; Does NOT Trigger: Buying bond of same company

- Triggers: Substantially identical ETF; Does NOT Trigger: Buying ETF tracking different index

Consequence

Disallowed loss is added to cost basis of new shares.

This defers (but does not eliminate) the tax benefit.

Tax-Advantaged Investments

Tax-Exempt Income

- Municipal bonds (general): Federal Tax Exempt; State Tax Varies (often exempt in issuing state)

- Treasury securities: Federal Tax Taxable; State Tax Exempt

- Series EE/I bonds (for education): Federal Tax May be exempt; State Tax Varies

Tax-Deferred Growth

- Traditional IRAs and 401(k)s

- Annuities

- Whole life insurance cash value

Tax-Favored Treatment

- Long-term capital gains (preferential rates)

- Qualified dividends (preferential rates)

- Tax-loss harvesting opportunities

In Practice

Tax-efficient strategies include:

- Holding assets more than 1 year when possible

- Placing tax-inefficient assets (bonds, REITs) in tax-advantaged accounts

- Harvesting losses strategically (watch wash sale rule)

- Using municipal bonds for high-bracket taxpayers

- Timing capital gains with low-income years

On the Exam

Series 65 frequently tests:

- Distinguishing short-term (ordinary income) from long-term (preferential) treatment

- The 30-day wash sale window (61 days total)

- $3,000 limit on ordinary income offset from capital losses

- Understanding NIIT applies above $200K/$250K thresholds

Key Takeaways

1. Long-term gains require holding MORE than 1 year (at least 1 year + 1 day)

2. Long-term rates: 0%, 15%, or 20% depending on income

3. NIIT adds 3.8% for high earners (max effective rate 23.8%)

4. Wash sale rule: 30 days before or after = 61-day window

5. Capital losses offset gains first, then up to $3,000 of ordinary income

6. Unused capital losses carry forward indefinitely