Warren Buffett’s investment advice is highly regarded, since he has had great success growing his fortune through prudent investments. But listening to Buffett might do more than just help you make smarter investments; it could also reduce taxes on your profits.
This key piece of advice could mean paying less to the IRS
Of all the advice from Buffett, the tip that could help slash the taxes you owe on investment gains is simple: “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
Long-term investors tend to do better at beating the market than those seeking short-term gains, so this advice is wise for a number of reasons. But it’s especially helpful because you’ll be taxed at the lower long-term capital gains rate, a huge difference in what you owe the IRS.
Gains on investment income aren’t always taxed as ordinary income. They’re divided into two categories: long-term and short-term capital gains. If you own an investment for less than a year, any profit when you sell it is a short-term capital gain, which will be taxed at your ordinary income tax rate. But if you own it for more than a year, it’s a long-term capital gain, taxed at a much lower rate. The table below shows the long-term capital gains rates for 2020:
|
Filing Status |
No long-term capital gains tax with income up to: |
15% long-term capital gains tax with income between: |
20% long-term capital gains tax with income above: |
|---|---|---|---|
|
Single |
$40,000 |
$40,000 to $441,450 |
$441,450 |
|
Married filing jointly |
$80,000 |
$80,000 to $496,600 |
$496,600 |
|
Head of household |
$53,600 |
$53,600 to $469,050 |
$469,050 |
|
Married filing separately |
$40,000 |
$40,000 to $248,300 |
$248,300 |
Table source: IRS.
A quick look at that table reveals that for millions of Americans, investing for more than a year will mean paying the IRS nothing at all on capital gains. And even for those in higher income tax brackets, the long-term capital gains rate is far lower than the rate on other income, including investments held for less than a year.
If you only make investments that you’re comfortable holding for a decade, as the Oracle of Omaha says, there’s little reason you’ll need to sell before that 12-month milestone on capital gains taxes. Even if you profit in the first year of ownership, if you picked a stock with solid long-term prospects, why wouldn’t you hold on to it? An early profit may be a sign that your investment is a wise one that will continue to perform well for years. So selling prematurely could cost you potential future gains while also exposing you to higher taxes.
In rare situations, the fundamentals of a company may change, and you’ll take whatever profits you’ve made within a year and run. But if you’ve done the research to find a company good for the long haul, that shouldn’t happen.
