The COVID-19 crisis has spurred a full-blown recession that's left countless Americans grappling with income insecurity. If you're in a financial crunch due to the pandemic and you have investments in a brokerage account, you may be thinking of cashing some out to put money in your pocket to pay the bills. This especially holds true if you're holding investments that haven't lost value since the pandemic began.
Back in March, the stock market crashed in a very big way as COVID-19 became an increasingly dangerous threat. But while that threat still exists, the market has somehow managed to recover since March, to the point where liquidating investments won't necessarily mean locking in losses. Quite the contrary -- some of your investments may be trading higher than they were when you first bought them, leaving you with a profit on your hands. But if you're going to cash those out, make sure you've held them for at least a year and a day first. Otherwise, you could have a tax nightmare on your hands.
How capital gains taxes work
Whenever you earn money, the IRS tries to get a piece of it, and investment gains are no exception. Capital gains are profits from investments, and they come in two varieties: short-term gains and long-term gains.
Short-term gains apply to gains from investments you've held for a year or less. When you sell those investments at a profit, you're subject to taxes that mimic the tax rate you'd pay on your ordinary income. For lower earners who live above the poverty line, that tax rate is 12% or higher. For moderate earners, it's between 22% and 24%. And for higher earners, it's between 32% and 37%.
On the other hand, long-term capital gains apply when you've held an investment for at least a year and a day before selling it. At that point, you're subject to a much lower tax rate when you sell investments at a profit. If your income is below $40,000 as a single tax filer or below $80,000 as a married couple filing jointly, your long-term capital gains tax rate is -- wait for it -- 0%. That's right -- you won't owe the IRS anything.
Meanwhile, most taxpayers will be subject to a long-term capital gains tax rate of 15%. Only higher earners -- singles earning more than $441,450 and joint filers earning more than $496,050 -- will be subject to the highest long-term capital gains tax rate of 20%, which is still lower than what moderate earners pay for short-term gains.
It's for this reason that it really pays to hold investments for at least a year and a day before selling them, so if you need money in a crunch right now, liquidate your portfolio strategically. It could be the case that you're sitting on an investment with gains that you bought 352 days ago. Waiting a couple of weeks to sell it could spare you a world of tax liability.
Be smart about selling investments
When you're desperate for money, the last thing you need is to lose a chunk of it to the IRS in the form of short-term capital gains taxes. Be careful when selling investments these days so that you're able to bank as much cash for yourself as you can.