Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Taxable Event

What it is:

A taxable event is any occurrence that creates a tax liability.

How it works (Example):

Many day-to-day financial activities are taxable events, but in the investing world the most common are the receipt of income, interest or dividends, and the creation of capital gains (usually through selling assets for a profit).

For example, let's assume Jane has saved her money over the years and has accumulated $100,000 in a mutual fund. Jane wants to use $25,000 of her nest egg to buy a car. She's tempted to sell $25,000 worth of shares in her mutual fund, but because those shares have appreciated in value, doing so would be a taxable event (the sale would generate capital gains, which are taxable). 

Jane calculates that she would owe capital gains tax of $2,250 if she sells shares of the mutual fund. She also calculates that a four-year car loan for $25,000 at the dealer's promotional 3% rate would only cost $1,561 in interest. Because of the taxable event associated with using her mutual fund investments, Jane calculates that it is cheaper to borrow the money to buy the car.

Why it Matters:

The key to being tax-efficient is knowing what taxable events are and then limiting those events as much as possible. 

Though most taxable events are obvious and well-known, some are not -- for example, taking money out of a retirement plan and then taking too long to roll it over into a new retirement plan; defaulting on a mortgage; benefiting from loan forgiveness; and converting a traditional IRA into a Roth IRA are all taxable events.