If you woke up to quadruple-digit gains on GameStop (GME +0.37%) stock, you're probably living every investor's fantasy. Shares of the video game retailer have surged more than 1,500% since the beginning of the year, driven by coordinated buying efforts of traders on popular social media sites such as Reddit.
Although there's much debate over the future of GameStop, there's no doubt that the stock is one of the hottest investments in the market right now. Anytime a stock experiences a meteoric rise within a short period of time, investors are left with a difficult decision: Should I buy more, hold, or sell?
No matter what decision you make, this is the best time to start thinking about smart tax strategies that will allow you to enjoy more of your stock market victories.
IMAGE source: Getty Images.
Cashing in on profits early can cost you
With the meteoric rise in GameStop stock, it's tempting to cash in on all profits and go on a shopping spree. But before you give up all your money, you should remember this: Selling stock in a regular brokerage account is a taxable event. This extra income you accrued while you were sleeping -- although unearned -- will put you on the hook for capital gains taxes.
Don't panic just yet. Capital gains are proof that you've made money in the stock market, and that's the ultimate reward for investors. Anytime you sell a stock in your investment account for a higher price than you purchased it for, you join the capital gains club. Let's say you purchased 1,000 shares of GameStop stock for $20 per share and sold all your shares for $300 per share. That's a $280,000 capital gain.
Just remember that you'll have to share your gains with the IRS in the form of taxes. Your tax bill is partially determined by your holding period, or, in simpler terms, how long you've held the stock. If you held your GameStop stock for a year or less, you pay a short-term capital gains rate. Those tax rates are similar to the taxes you pay from working a job, climbing as high as 37% for those with the highest taxable income.
The secret to lowering your taxes
Fortunately, there are some lower tax rates on certain capital gains. If you were ahead of the curve and purchased GameStop stock more than a year ago, you're in luck. You qualify for the long-term capital gains tax rates of 0%, 15%, and 20% that are listed below, subject to an additional 3.8% net investment income tax for higher earners. In order to unlock these rates, you are required to hold your stock for over a year before selling.
So if you bought 1,000 shares of GameStop stock on Jan. 26, 2020, you could sell them lon Jan. 27, 2021, you've hit the minimum time period to qualify for the favorable long-term capital gains rates.
But if you haven't yet owned the stock for longer than a year, waiting for your one-year stock anniversary with GameStop stock is dangerous, given how insanely volatile the stock has been lately.
2021 long-term capital gains tax brackets
|
For single filers with taxable income of... |
For married joint filers with taxable income of... |
For heads of households with taxable income of... |
...this is the long-term capital gains rate |
|---|---|---|---|
|
$0 to $40,400 |
$0 to $80,800 |
$0 to $54,100 |
0% |
|
$40,401 to $445,850 |
$80,801 to $501,600 |
$54,101 to $473,750 |
15% |
|
Over $445,851 |
Over $501,601 |
Over $473,751 |
20% |
Data source: IRS.
Make the best decision for your portfolio
If you don't have faith in GameStop's longevity, there's no need to hold on to your stock for the sake of taxes. You can always take gains now and take advantage of tax-loss harvesting to offset your short-term gains with short-term losses from other stocks in your portfolio that have lost their sparkle. This is a popular strategy that is frequently used by investors aiming to reduce their tax bill.
But if you would rather skip the entire tax process altogether, you can always hold your investments in tax-sheltered accounts such as the Roth IRA. This retirement account allows you to buy and sell stocks whenever you want so you can enjoy more tax-free income during retirement.
