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

Long-Term Capital Gains

2025 Long-Term Capital Gains Brackets

Special Capital Gains Rates

Net Investment Income Tax (NIIT)

An additional 3.8% tax applies to the lesser of:

• Net investment income, OR
• MAGI above threshold

Maximum Effective Rate: 20% + 3.8% = 23.8% for 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 → $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

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

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