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When you invest in the stock market, you expect to get capital gains. But you do not want to lose your hard-earned capital to taxes, right? So, Swiss investors need to know how Switzerland taxes capital gains.
Capital gains are something that many people do not understand correctly. And this is especially true when it comes to Capital Gains Taxes. I have received many questions regarding how capital gains are taxed in Switzerland. I am specifically talking about capital gains and the stock market.
So I decided it was time to dedicate an entire article about Capital Gains and how they are taxed in Switzerland. It is not a very difficult subject. But it is an essential subject!
Hopefully, this will help more people understand how this works! Fortunately, we have a country where we can avoid taxes on capital gains, but the rules are not clear.
Capital Gains in the Stock Market
Capital Gains are the gains you make when you sell stocks at a price higher than the amount at which you have bought them. For instance, you purchased ten ETF shares at 100 USD, and you sold them at 200 USD. As a result, you have realized 1000 USD capital gains (10 shares times 100 USD gain per share) in this example.
Capital gains are based on the appreciation of value. And they are only counted when you sell. So if you have not sold yet, you could say that you have some unrealized capital gains. But we are going to focus on realized (sold) capital gains.
In this article, I will mainly talk about stocks. But the same rules apply to bonds. There is no difference in capital gains between stocks and bonds.
Capital gains do not only apply to the stock market. They can apply to everything that appreciates. The other important area is real estate. In theory, you could even have capital gains when you sell anything at a higher price than the one you bought it at. However, for this article’s sake, we will focus on capital gains in the stock market.
Capital Gains Tax
What is very important with capital gains is that most countries have taxes on capital gains. So it means that you need to take this tax into account when you invest.
However, in Switzerland, capital gains are generally tax-free. It means that investing in the stock market for the appreciation of stocks or ETFs is very efficient. You can double your money without paying taxes on it. This appreciation will still increase your wealth tax, so will any income. But it means that income through capital gains is one of the only forms of income that will not be taxed twice in Switzerland.
Not having to pay taxes on capital gains can make it much easier to retire early in Switzerland. Most countries will tax your capital gains. And in some countries, capital gains tax is very high. For instance, in France, you will pay a third of your capital gains as taxes! In Russia, you would pay 20% in taxes. But in our great country, you will generally pay 0% in capital gains tax!
You can read more about this on the official website of Switzerland. The website states that gains in the value of privately owned shares and bonds are tax-free as long as the private investor is not classified as a professional investor.
Indeed, I said that capital gains are generally not taxed in Switzerland. Indeed, by default, they are tax-free. But if you qualify as a professional investor, you will have to pay a tax on your capital gains (counted as income). In that case, your capital gains will be added to your taxable income and taxed as such.
Professional Investor status
By default, people are considered private investors by tax offices. A private investor invests in the stock market the money he is earning through other sources of income. It means he is not living from his investments. He is simply using the stock market to earn more money.
The federal tax office uses five different criteria for differentiating private investors and professional investors:
- Private investors should hold securities for at least six months before selling them.
- Capital gains of private investors do not account for more than 50 percent of their net income.
- The total volume of transactions (purchases and sales) of a private investor does not account for more than five times the value of the investment portfolio at the beginning of the tax period.
- Private investors invest with their own money, not with loans.
- Private investors do not use derivatives (especially options) unless they are for hedging the risks on their securities.
If you tick all of these criteria as a private investor, your capital gains will not be taxed. On the other hand, if an investor does not tick all these rules, he may be considered a professional investor. When you tick all the rules, tax offices are doing a thorough review to decide whether they are professional investors or not. But an investor will likely be a professional investor when ticking all these criteria.
For people that tick only some of the rules, it will be up to the local tax office to decide whether they are professional investors or not. You would need to violate at least two of these rules to be considered a professional investor in practice.
Local tax offices use these criteria as rules of thumb. It means that tax offices can use their own rules. But generally, they are using these five rules or a subset of these rules. The first three rules are the most important to tick.
The third rule is straightforward to avoid: hold your securities and do not try to time the market. If you invest passively in a few ETFs, the total transaction volume will always be much less than five times the value of your securities.
The first rule should be easy, as well. If you are a long-term investor, for instance, pursuing Financial Independence, you want to buy your shares with the intent to sell them in a very long time. So, you should have no issues with this rule.
The second rule is generally not bad. When you are working, you will likely get significantly more income than your capital gains. Therefore, your capital gains will not be taxed.
If you do not fit into one of these rules, this does not mean you will be considered a professional investor. In the end, it is still a human that will decide on your status. For instance, if you held some of your securities for only five months, but all the other rules are fine, you will not be considered a professional investor. Or, if you invest more than five times your portfolio in a year but generate minimal capital gains, you will not be considered as such either.
It is also important to remember that very few people are considered professional investors in Switzerland. This means you need to trade a lot to be considered as such. I am not saying you should not be careful. But I am saying that as long as you are a passive investor, the risks are minimal.
Since every state can work around these five rules, you may want to contact your local tax office if you are unsure of your status.
But if you are trying to become Financially Independent and live out of the stock market, this may be different.
Are FI People Professional Investors?
When you are Financially Independent and retired, you will not have much income. You may even have zero income for a long time. It means you will live out of your capital gains. But you do not want them to be taxed.
But since your capital gains make for more than half of your income, should you be considered a professional investor?
In theory, you could, yes. But in practice, you will only have one failed criteria. And generally, people are not considered professional investors only by a single criterion. You should meet several of these criteria for your capital gains to be taxed. Again, you can contact your local tax office if you want to be sure about that.
And there is something else as well: dividends. If you invest in the global stock market, you will receive dividends. Dividends are counted as income. So if you live half on your dividends and half on your capital gains, you should be fine.
In general, most ETFs have about a 2% dividend rate. Since most people retire on the four percent rule, they only need 2% of capital gains. This is a good split. But this can vary highly from one year to another, so we need to be careful.
Now, this is one place where distributing ETFs are much better than accumulating ETFs. If you only own accumulating ETFs, you will need to sell more of them to pay your bills. As such, you will generate more capital gains. Realized income is why I prefer distributing ETFs over accumulating ETFs.
Also, even if you sell 2% of your net assets every year to live, this will not be entirely capital gains. Some of the money you get is the money you paid to buy the shares. But over the long-term, you want capital gains, not invested money. But still, this will reduce the risk of having too much income from capital gains.
When you are in retirement, a little income will go a long way in helping you retire. So, if some income stream covers a quarter of your expenses, you only need dividends and capital gains for the other three quarters. In that case, it is improbable that your capital gains exceed your dividends and the side income.
And if you use a more conservative withdrawal rate, it will be even easier to have half of your income in dividends.
Finally, there is something good with capital gains. You can control them. It means you decide when you gain capital gains. So, based on the 50/50 split, you can control how much capital gains you realize not to be considered a professional investor. Of course, this is not always possible. If you need the money for essential expenses, then this should not prevent you from selling.
Given all this, early retirees in Switzerland do not have to worry much about capital gains tax. If you want to be sure, you will have to contact your local tax office. But in practice, it is extremely rare for people to be classified as professional investors unless they are self-employed traders.
In general, we can assume that capital gains will not be taxed in Switzerland. It is an excellent thing because this means that a large part of your income will not be taxed in retirement.
Now, we still have to be careful not to be qualified as professional investors. Indeed, professional investors will have their capital gains taxed as income. But most of the rules for that are simply the rules of long-term passive investors (hold for more than six months and do not do many transactions).
The only thing that could happen is to be qualified as a professional investor in retirement because our capital gains make for more than half of our income. But in practice, this should not happen. Indeed, you should also receive dividends. And you may have a side income that will help in that matter as well.
Moreover, very few people are classified as professional investors. Unless you are day-trading, making many transactions, or using options to trade, you should not worry much about your investor status.
Hopefully, this will help clear the matter of capital gains and taxes in Switzerland.
If you want more information, I have an entire article about taxes in Switzerland. For instance, we should not forget that our wealth is taxed.