Most investors focus on returns and forget about the tax hit. But that can really cost you.
Financial advisors said several common capital gains mistakes can quietly drain your portfolio without you realizing it.
Lance Morgan, founder of College Funding Secrets, explained why this matters. “Taxes are the silent killer of the gains you could have if your money could grow tax-free or tax deferred,” he said. “Opportunity cost is the most expensive cost when paying capital gains taxes.”
When you sell investments and pay taxes, that money stops growing and compounding. Morgan pointed out that taxable investments are actually the most expensive investments because of this drag.
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One of the most common mistakes is selling just before hitting the 12-month mark, according to Jason Thrap, a financial advisor with Benson Wealth Management. “A sale of a stock one day short of a year is taxed as ordinary income, not at the lower long-term capital gains rate,” he explained.
The gap can be huge for higher earners. A $10,000 gain at 11 months gets taxed at 35% ordinary rates for $3,500 in taxes. Wait until 13 months and it drops to 15% long-term rates for $1,500. That’s a $2,000 difference for waiting a few weeks.
Thrap warned about mutual fund capital gain distributions late in the year. Funds distribute realized gains and if you hold the fund on the distribution date, you pay tax on those gains even if they came from prior years. “Buying right before year-end can trigger an unexpected tax bill,” he said.
Checking a fund’s distribution schedule before buying can help avoid this surprise.
Selling appreciated investments in a high-income year can push gains into higher brackets and trigger additional taxes, according to Thomas Brock, a CPA and expert Annuity.org. States often tax capital gains as ordinary income or have their own rules.
Thrap added that state taxes are frequently overlooked but can significantly increase the true cost. “A 9% state tax adds materially to your federal tax,” he explained.
Many investors don’t account for the 3.8% net investment income tax that hits when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples, Thrap said.
A $50,000 gain for a couple with income of $300,000 could trigger up to $1,900 extra tax from NIIT. People near these thresholds should model their income before making big sales.
