How investments are taxed can vary depending on the type or vehicle of investment you choose. Understanding the tax implications of different types of investments is vital for making informed decisions about your financial future.

Taxable vs. Tax-Advantaged Investments

One crucial factor to consider is the difference between taxable and tax-advantaged investments. Taxable investments, such as stocks, bonds, cryptocurrency, and other investments made through brokerage accounts, are subject to capital gains tax at the time you sell them for a profit — and this capital gains tax must be paid when you file your tax return. In contrast, using tax-advantaged investments, such as 401(k)s and IRAs, offer specific tax benefits that can help you save money on taxes.

What is a 401(k)?

401(k)s are employer-sponsored retirement plans that allow you to contribute a portion of your income to the plan before taxes are taken out. This means that the money you contribute to a 401(k) is tax-deferred, so you won't have to pay taxes on it until you withdraw the money in retirement. However, it's essential to remember that when you withdraw money from your 401(k) in retirement, it will be subject to income tax at your then-current tax rate. Additionally, there are penalties for early withdrawals from a 401(k) before the age of 59.5.

What is a Roth IRA?

Roth IRAs are individual retirement accounts to which you contribute money after taxes have been taken out. This means you don't get an immediate tax benefit for contributing to a Roth IRA, but the money in the account will grow tax-free, and when you withdraw the money in retirement, it will also be tax-free. Roth IRA contributions are also subject to contribution limits and phasing out based on income levels.

Real Estate Investing

Real estate investing has unique tax implications. Rental income is considered earned income and is subject to taxes, whereas depreciation can be taken as an expense to reduce taxable income.

It's also worth noting that taxes on investments can vary depending on where you live, as some states have their own income tax laws that can affect your investments.

What Is the Capital Gains Tax?

There are two types of capital gains tax: short-term and long-term. Luckily, both types are relatively straightforward — at least as far as taxes are concerned.

Short-Term Capital Gains Tax

Short-term capital gains tax applies when an investor realizes an investment held for under one year total — hence, “short-term”. There are no special rules for short-term capital gains; they are taxed as ordinary income.

Long-Term Capital Gains Tax

The 2018 Tax Cuts and Jobs Act lowered the long-term capital gains tax rate. And if you are a single filer, you don’t have to pay any tax on long-term capital gains of under $44,625 ($89,250 if married and filing jointly.

However, unless you live in Alaska, Colorado, Florida, Nevada, New Hampshire, New Mexico, South Dakota, Tennessee, Texas, Wyoming, or Washington, you also have to pay capital gains tax at the state level. The amount you have to pay varies from state to state — be sure to confirm what you’ll owe on your state’s Department of Treasury website.

Short Term Capital Gains Tax Rate

Unlike long-term capital gains, The IRS taxes short-term capital gains like regular income.

Source: Internal Revenue Service

When deciding how to invest your money, it's essential to consider the tax implications of each type of investment — and it can be helpful to consult with your local Liberty Tax Pro.

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If figuring out capital gains tax — or any tax matter — is giving you TAXiety and you want relief now, don’t hesitate — schedule an appointment with your local Liberty Tax. In-person meetings not your thing? You can start your return with our mobile app or utilize our virtual tax pro.

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