Capital Gains Exposure (CGE): Definition

KEY TAKEAWAYS

• Capital gains exposure evaluates how much an investment increased or decreased in value.
• A fund that has suffered a negative exposure can offset some of its future capital gains via a loss carry-forward. 
• You can limit your CGE via deferred taxable accounts such as an IRA or a 401(k).

What Is Capital Gains Exposure?

Capital gains exposure is an evaluation of how much investment assets in a stock or other comparable investment fund have increased or decreased in value. Knowing the amount or percentage of the appreciation will allow the investors to determine if they are exposed to capital gains. Investors who are exposed to capital gains may decide to sell other assets at a potential loss to offset the gains or to plan for needing to pay the taxes. 

On some investments, investors pay capital gains taxes when the investments have been sold. Those investments are usually stocks, bonds or real estate. On other assets, like some mutual funds, investors are required to pay capital gains taxes when the assets in the funds are liquidated. 

How Is Capital Gains Exposure Calculated

Positive capital gains exposure indicates that the investments have increased in value and that shareholders will be required to pay taxes on any profits made from the increased value of the assets. 

Here is how you can calculate your capital gain exposure:

If a fund started with $3,000, had a gain of $400 and a loss of $100 during the year, then the fund’s CGE would be 9.09%. This is calculated by dividing the net of $300 gain by the net total investment of $3,300.

If the fund started with $3,000, had a gain of $400 and a loss of $500, then the fund’s CGE would be -3.4%. This is calculated by dividing the net loss of $100 by the total net assets of $2,900.

In the loss scenario, a fund with negative exposure would have a loss carry-forward that can help offset some of its future capital gains.

It can be calculated as follows: 

How to Limit Capital Gain Exposure

There are a number of ways that you can limit your capital gain exposure. 

Hold every single mutual fund you own, to the degree possible, in an IRA, 401(k), or other tax-deferred accounts. In that case, your capital gains distributions would have no impact whatsoever.

Instead of active mutual funds, try investing in index mutual funds or ETFs. You’re less likely to have the manager sell assets to realize gains because index funds have a lower turnover rate. Additionally, ETFs increase protection by preventing the requirement for asset sales as a result of investor redemptions.

One further precaution you may take if you absolutely want an active mutual fund is to steer clear of those with high tax-cost ratios, which measure how much a fund’s yearly tax returns are impacted by tax obligations.

When investing in stocks, try to sell stocks with a positive capital gains exposure in the same year that you sell stocks with a negative gains exposure. The gains will offset the losses.

When investing in real estate, consider a 1031 exchange. In a 1031, you use the gains from a real estate property sale to buy another property. This will defer the taxes until you sell the second (or if you repeat the exchange, the last) property.

How to Avoid Large Capital Gains Taxes

An educated investor will know when there is a potential capital gains exposure. There are many tactics that they can employ to avoid large capital gains taxes. One of the important pieces of information to know is the difference between short and long term capital gains tax rates. Short term capital gains are taxed using the ordinary income tax rate, which is usually higher.  Below is a list of some additional tactics: 

1. Long-term investing

2. Utilize tax-deferred programs

3. Monitor your holding times

4. Decide on a cost basis

5. Use capital losses to offset capital gains

Summary

With a few exceptions, people and businesses in the US must pay income tax on their net total of all capital gains. The ordinary income tax rate is applied to short-term capital gains, which is a higher rate. 

In some tax categories, there is no tax owed on “long-term capital gains,” which are gains on assets held for longer than a year before being sold, for people. This rate is lower than the rate on a regular income.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.