Taxes: How they work
When you make money on an investment AND you sell it, you will be taxed on that gain. If you held the investment under a year the gains count as income. If you held it more than a year, it will be taxed as capital gains. When you lose money on an investment AND you sell it, you can usually deduct that loss from your tax bill as well. The exception is, if you sell an investment at a loss and purchase an effectively identical investment within 30 days you will have created a wash sale and will not be able to deduct the loss. Written out, the rules for taxes are as follow:
| Change | Rule | Rate | Taxed Type |
|---|---|---|---|
| Gain | < 1 year | Sign In | Income Tax |
| Gain | > 1 year | Sign In | Capital Gains Tax |
| Loss | < 1 year | Sign In | Income Tax, subject to wash |
| Loss | > 1 year | Sign In | Capital Gains Tax, subject to wash |
| Dividends | N/A | Sign In | Income Tax |
Knowing how taxes are calculated is just the beginning. The magic is in being able to use these rules to your advantage. The rest of this article describes actual mistakes in a hands on way.
Strategy: The Rebalance
One common reason you are going to run into taxes is because you want to rebalance your portfolio. Often targets are set for a particular mix of stocks (For example: 90% VTI and 10% individual stocks). Unfortunately your portfolio is going to drift away from this mix over time. This can happen because a stock earns particularly well or alternatively because a stock is reduced in value. Even if stocks don't drift significantly from your targets you still might end up considering rebalancing because your risk tolerance has changed. Regardless of the reason, bringing your investments into line with your goals can result in a large tax bill.
Option: Change Future Contributions
One common way to handle an imbalance in your portfolio is to simply adjust future contributions to your account (or adjust dividend reinvestment). This will can gradually increase the percentage of the underweighted items, bringing the portfolio back to the desired balance. The advantage of this is that there are not going to be any taxes incurred because there are no stock sales happening (which is when taxes are incurred)! Of course, there is a distinct disadvantage as well - it can take a considerable amount of time to rebalance. Depending on your particular goals, you may not want to wait that long. Also, this can help adjust the percents of securities you own but it can't remove a particular stock from your mix entirely.
Option: Trade to Adjust
The other common way to change your portfolio mix: sell overweighted stocks and purchase underweighted stocks. This can incur serious taxes but it actually doesn't have to! The reality is taxes are going to depend heavily on the current price of the stocks that you are buying and the term that you have held them for. So, instead of just reading about this we wanted to give you a simulator to TRY IT OUT!
Use the following calculator to input your current portfolio, then run simulations to help you get to your desired balance. You can see the estimated tax and final balance of the portfolio below the calculator. Note that tax rates are estimated based on your settings only if you are signed in, so be sure to look at those. Also, note that the tax estimate from this tool is based on the previous closing price for whatever stocks you are purchasing or selling. Most likely your actual sale price is going to be different than this so take the tax estimate with a grain of salt. One final note - if you want to get your tax estimate for actual taxes you can do that by creating a portfolio here.
Tax Simulator
Now
| Ticker | Purchased | Qty | Cost | % |
|---|---|---|---|---|
| -- | -- | -- | -- | -- |
Goal
| Ticker | Goal (%) | After Changes (%) |
|---|---|---|
| -- | -- | -- |
Do It!
| Ticker | Date | Qty | Dir |
|---|---|---|---|
| -- | -- | -- | -- |
Estimated Tax: $0.00
Your Tax Settings:
Income tax rate of 22
Capital gains rate of 15
Sign in to change settings
DISCLOSURES
Content is provided for informational purposes only, does not constitute tax or investment advice, and is not a recommendation for any security or trading strategy. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results. This tool is NOT intended to be used for tax preparation or filing purposes and represents and ESTIMATE of your taxes. To perform exact tax preparation and planning please see a certified tax or accounting proffesional. This site does not provide any liability - express or implied - for the information you receive. Any details you choose to act on should be reviewed by a certified proffesional. If you do notice a scenario that is incorrect please let us know through the feedback tool on your screen!