When an investment is sold, capital gains tax is owed on the profit made by the investor. It is owed for the tax year when the investment was sold.
Long-term capital gains taxes are 0%, 15%, or 20%, depending on the income of the filer.1 Income brackets are adjusted annually.
When an investor owns an investment for at least a year, he or she will be taxed on long-term capital gains. For taxpayers who own investments for less than one year, short-term capital gains tax applies. For all taxpayers but the highest-paid, that is a higher tax rate than capital gains tax.
What You Should Know
- Taxes on capital gains are due only after an investment is sold.
- In addition to stocks, bonds, cryptocurrencies and NFTs, jewelry, coin collections, and real estate, capital gains taxes apply only to “capital assets.”
- Investment profits held over a year are taxed as long-term gains.
- Taxing short-term gains at the individual’s regular income tax rate is higher than taxing long-term gains for most people, except for the wealthiest.
A Guide to Capital Gains Taxes
A capital gain or profit, referred to as a “realized capital gain,” is when stock shares or other taxable investment assets are sold. The tax does not apply to unsold investments or “unrealized capital gains.” Shares of stock do not incur taxes until they are sold, no matter how much they increase in value or how long they are held.
According to current federal tax policy, capital gains are taxed only on gains from assets held over a year, referred to as long-term capital gains. The current rates are 0%, 15%, or 20%, depending on the taxpayer’s tax bracket.
The average taxpayer pays a higher rate on income than on long-term capital gains. This encourages them to hold investments for at least a year, after which the tax rate on profits is lower.
Any profits made from buying and selling assets held less than a year are taxed at a higher rate than profits earned from assets held longer. This applies to day traders and others taking advantage of the ease and speed of trading online.
In other words, your tax is due on your net capital gain for the year. Capital losses can be reduced from your taxable capital gains. Net losses are limited to $3,000 per year, but leftover losses can be carried forward to the following year.
Adding to the existing 3.8% investment surtax on individuals earning more than $1 million, the tax on those individuals could increase to 43.4% without counting state taxes in 2021, according to President Biden.
Rates of capital gains taxes for 2022 and 2023
Generally, assets that are sold less than a year after they are purchased are treated as wages or salaries for tax purposes.1 Such gains are added to earned or ordinary income on your tax return.
A dividend is the same as a capital gain, except that it isn’t taxed as ordinary income in the U.S. If you fall into the 15% or higher tax bracket, dividends are taxed as ordinary income.
There is, however, a different system for long-term capital gains. Depending on the taxpayer’s taxable income for a given year, taxes are assessed based on a rate schedule for assets held for more than a year and sold at a profit. Each year, inflation is adjusted into the rates.
The following tables show the tax rates for the tax years 2022 and 2023:
2022 Tax Rates for Long-Term Capital Gains
|Single||Amounts up to $41,675||$41,675 to $459,750||$459,750 or more|
|Household head||Amounts up to $55,800||$55,800 to $488,500||$488,500 or more|
|Couples filing jointly and surviving spouses||Amounts up to $83,350||$83,350 to $517,200||$517,200 or more|
|Separate filings for married couples||Amounts up to $41,675||$41,675 to $258,600||$258,600 or more|
If you hold taxable assets for at least a year, you will pay the following tax.
2023 Tax Rates for Long-Term Capital Gains
|Single||Amounts up to $44,625||$44,626 to $492,300||$492,301 or more|
|Household head||Amounts up to $59,750||$59,751 to $523,050||$523,051 or more|
|Couples filing jointly and surviving spouses||Amounts up to $89,250||$89,251 to $553,850||$553,851 or more|
|Separate filings for married couples||Amounts up to $44,625||$44,626 to $276,900||$276,901 or more|
Your taxable assets that have been held for more than a year will be taxed at the following rates.
As shown in this table, long-term capital gains are taxed at lower rates than individual income, as has been the trend for decades.
Exceptions and special rates for capital gains
Capital gains tax treatment differs for some types of assets.
You pay a 28% tax on collectibles, including art, antiques, jewelry, precious metals, and stamp collections, regardless of your income. Capital gains taxes are limited to 28% if you’re in a higher tax bracket. If you’re in a lower tax bracket, you’ll be taxed at the lower rate.
Real Estate Occupied by Owners
You don’t have to pay taxes on real estate capital gains if you sell your principal residence. For individuals, $250,000 of capital gains on selling a home are excluded from taxable income ($500,000 for married couples).
If the seller has owned the home for at least two years and lived there, he or she is eligible for this exemption.
Personal property, such as a home, does not qualify for a capital loss deduction, unlike some other investments.
Here’s how it can work. If a single taxpayer buys a house for $200,000 and then sells it for $500,000, they have made a $300,000 profit. In order to qualify for the capital gains tax exemption, this individual must report a capital gain of $50,000 after applying the $250,000 exemption.
Capital gains are usually reduced if significant repairs and improvements are made to the home.
Investing in real estate
It is common for investors to deduct depreciation from their income in order to reflect the deterioration of their properties over time. (This is not related to the property’s changing value.)
By deducting depreciation, you reduce the amount you are considered to have paid for the property. Thus, if you sell the property, you may generate a higher taxable capital gain because the value of the property after deductions is greater than its sale price.
The $5,000 treated as recapturing those depreciation deductions in a sale of real estate is treated as if you paid $95,000 for the building.
In the event the building is sold for $110,000, the person would be taxed at 25% on the recaptured amount. If the person then sold the building for $110,000, the capital gain would total $15,000. The recaptured amount of $5,000 is taxed at 25%, while the remaining $10,000 capital gain would be taxed at 0%, 15%, or 20%, depending on the investor’s income.
Exceptions to investing
A net investment income tax may apply if your income is high.
Upon exceeding certain thresholds, you will be taxed an additional 3.8% on your investment income, including your capital gains
When you are married and filing jointly or if you have a surviving spouse, the threshold amounts are $250,000; when you are single or a head of household, the threshold amounts are $200,000; and when you are married and filing separately, the threshold amounts are $125,000.
Capital Gains Calculation
You can deduct capital losses from capital gains to calculate your taxable gains.
When you have incurred long-term and short-term capital gains and losses, the calculation becomes a little more complicated.
Sort short-term gains and losses separately from long-term gains and losses. Short-term gains are then added up, short-term losses totaled, and long-term gains and losses added up.
In order to calculate the net short-term gain or loss, the short-term gains are netted against the short-term losses.
A capital gains calculator can help you estimate what you will pay if you sell your home (or have a professional figure it out for you).
Tax Strategies for Capital Gains
It is true that the capital gains tax reduces the investment’s return. However, some investors have legitimate ways to minimize their net capital gains taxes.
You will typically pay less tax on long-term capital gains than on short-term gains if you hold assets for more than a year before selling them
Take advantage of your capital losses
Losses will offset capital gains and reduce capital gains tax for the year. But what if losses exceed gains?
Losses that exceed gains by up to $3,000 can be deducted from income, and any excess loss that is not used in a given year may be deducted from income for future years.
Suppose an investor realizes a $5,000 profit from the sale of some stocks, but incurs a $20,000 loss from the sale of others. In this case, the capital loss cancels out tax liability for the $5,000 gain. Those earnings can be offset by the remaining $15,000 capital loss.
Accordingly, if an investor has $50,000 in annual income, the first year he or she can report $50,000 less the maximum annual claim of $3,000. That amounts to $47,000 in taxable income.
There are still $12,000 of capital losses to deduct, so the investor can take the maximum deduction of $3,000 each year for the next four years.
Don’t violate the wash-sale rule
The IRS wash-sale rule prevents you from repurchasing the same investment within 30 days or less of selling it at a loss for a tax advantage.
Schedule D reports any material capital gains.
To reduce any income in the future and lower the taxpayer’s tax burden, capital losses can be carried forward.
Take advantage of tax-advantaged retirement plans
401(k)s and IRAs allow you to grow your investments without paying capital gains taxes each year, which is one of the many reasons to participate in one. Essentially, you can buy and sell within a retirement plan without losing a cut each year to Uncle Sam.
Generally, participants do not pay taxes until they withdraw funds from the plan. However, withdrawals are taxed as ordinary income regardless of the underlying investment.
IRAs and 401(k)s are the exceptions to this rule, for which income taxes are collected when funds enter the account, meaning qualified withdrawals are tax-free.
After retiring, you can cash in
Depending on your retirement income, you might be able to reduce or even avoid capital gains taxes by waiting until you actually stop working to sell profitable assets.
It’s a good idea to consider the impact of taking the tax hit while working instead of after retirement. The gain you realize earlier may bump you out of the zero- or low-pay bracket and result in an additional tax bill.
Be aware of your holding periods
For an asset to qualify as a long-term capital gain, it must be sold more than one year after it was purchased. Be sure to check the actual trade date of a security you are selling before you sell it if you were to buy it about a year ago. If you wait for only a few days to sell, you may be able to avoid treating it as a short-term capital gain.18
When you are in a higher tax bracket than when you are in a lower one, these timing maneuvers matter more.
Decide on your basis
For determining the cost basis of shares acquired and sold at different times in the same company or mutual fund, investors typically use the first-in, first-out (FIFO) method.
In addition to LIFO, there are four other methods to consider: average cost (only for mutual fund shares) and last in, first out (LIFO).
If your situation is complicated, you may need to consult a tax advisor. Several factors must be considered, such as the basis price of the shares or units purchased and the amount of gains that will be declared.
It can be difficult to calculate your cost basis. If you use an online broker, your statements will be available via its website.
If you don’t have the original confirmation statement or other records from that time, finding out when and at what price a security was purchased can be a nightmare. It can be difficult to determine exactly how much you gained or lost when selling a stock, so keep track of your statements. For the Schedule D form, you will need those dates.
How Do You Know When You Owe Capital Gains Taxes?
As an example, if you sell some stock shares anytime during 2022 and make a total profit of $140, you must report that $140 as a capital gain on your tax return for 2022.
A Schedule D form is used to report capital gains taxes on investments sold after a year of holding.
For the 2022 and 2023 tax years, the capital gains tax rates are 0%, 15%, or 20%, depending on your taxable income. The percentages are adjusted for inflation every year.
Generally, if you hold investments for less than one year, the profits are taxable as ordinary income.
What are the best ways to avoid capital gains taxes?
There are a number of perfectly legal ways to minimize capital gains taxes if you want to invest money and make a profit.
- Make sure you hold onto your investment for at least a year if you want to avoid having to pay more tax on your profit.
- The amount you can deduct from your investment profits, up to $3,000 a year, can be deducted from your investment losses.1 Some investors take advantage of this fact. In order to offset their gains for the year, they may sell a loser at the end of the year.
- In the future, you can deduct losses greater than $3,000 from your capital gains.
- Expenses incurred making or maintaining your investment will increase its cost basis, thereby reducing its taxable profit.
Is Reducing Capital Gains Tax Rate a Good Idea?
There are those who argue that a low capital gains tax rate is a great incentive for people to save and invest their money in stocks and bonds. That increased investment fuels economic growth, enabling companies to expand and innovate.
The investors are also using after-tax income to buy those assets. The money investors use to buy stocks or bonds has already been taxed as ordinary income, so adding a capital gains tax is double taxation.
Capital Gains Tax Rate Reduction: What’s the Problem?
A low rate on capital gains is questioned by opponents for shifting the burden of taxes onto working people. A low rate on capital gains shifts the burden of taxes onto earning income.
Additionally, they assert that a lower capital gains tax benefits the tax-sheltering industry. That is, instead of using their money to innovate, businesses park it in low-tax assets.