Sure, the capital gains tax rules are complicated. But if you use them to your advantage, you can significantly cut your tax bill. You do that by selling some of your losers to offset gains. Simple enough, right? Well, it gets tricky when you have both short-term and long-term gains and losses. But we'll try to make it as straightforward as possible.
Long-Term Vs. Short-Term
The first step is to separate your short-term capital gains and losses from your long-term gains and losses. That's because long-term gains are taxed at those lower capital gains rates you hear so much about, while short-term gains are taxed at your regular rate (which can run as high as 35%).
Short-term investment assets are those you've held for one year or less (not less than one year, as you commonly hear). And long-term investments are those you've held for more than one year. For purposes of meeting the more-than-one-year rule, your holding period is considered to begin on the day after you acquire the investment asset. It ends on the day you sell. In effect, you don't count the day you buy. But you do count the day you sell.
For example, say you buy 100 shares of Cisco (CSCO) on Nov. 15, 2004. Your holding period starts on the 16th. If the shares go up and you want to take advantage of the lower tax rate on long-term capital gains, you can't sell before Nov. 16, 2005 -- exactly a year and a day after your holding period began.
The Netting Rules
Your next step is to add together all your gains and losses. First, you net your short-term gains and losses -- that is, you calculate each individual gain or loss by subtracting the purchase price of the securities (including commissions) from the sales proceeds net of commission. Then just sum everything up. You'll come up with an overall net short-term gain or loss figure. Next, you net your long-term gains and losses in the same fashion. You'll end up with either a net long-term loss or a net long-term gain.
Now you need to net your short- and long-term figures to come up with a final tally. This is where it gets really complicated. And if you have both short and long-term gains and losses, deciphering what it all means is enough to make your head feel like you just took a couple of spins on the Lightning Loops roller coaster at Great America.
But our table below will help you untangle the snarl. Simply find the intersection of your short-term and long-term scenarios. You can then see what this means for your tax bill.
*If married and filing separately, the deduction limit is $1,500.