When you sell an investment for more than you paid for it, your profit is considered a capital gain. If you’ve held the asset for a year or less, that’s a short-term gain. Any profit made after that time period is considered a long-term gain.
Capital gains qualify for special tax consideration, so it’s important to understand the differences between short-term versus long-term capital gains and the ways in which you can minimize their effect on your tax bill.
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Capital gains represent the positive difference between the purchase price of an asset and the sales price of an asset. If you buy an investment for $100 and sell it for $150, for example, your capital gain is $50.
Capital gains are subject to federal taxes, but the tax rate depends on whether it is a short- or long-term capital gain. To quantify how long you’ve held an asset, you will typically count from after the day you acquired it and include the day you sold it.
Because short-term gains are taxed as ordinary income, they’ll be taxed at your marginal tax rate, as shown in the table below.
|Short-Term Capital Gains Rates|
|Single, taxable income over ...||$0||$9,875||$40,125||$85,525||$163,300||$207,350||$518,400|
|Head of household, taxable income over ...||$0||$14,100||$53,700||$85,500||$163,300||$207,350||$518,400|
|Married filing jointly, taxable income over ...||$0||$19,750||$80,250||$171,050||$326,600||$414,700||$622,050|
|Married filing separately, taxable income over ...||$0||$9,875||$40,125||$85,525||$163,300||$207,350||$311,025|
Meanwhile, your long-term capital gains rate will depend on your annual income and filing status, as indicated in the table below.
|Long-Term Capital Gains Tax Rates|
|Single||$0 to $40,000||$40,001 to $441,450||$441,451 or more|
|Head of household||$0 to $53,600||$53,601 to $469,050||$469,051 or more|
|Married filing jointly||$0 to $80,000||$80,001 to $496,600||$496,601 or more|
|Married filing separately||$0 to $40,000||$40,001 to $248,300||$248,301 or more|
Calculating your capital gains isn’t too complicated. Here’s how it works:
Suppose you purchase 100 shares of stock priced at $50. Your total purchase price is $5,000. Two years later, you sell those 100 shares of stock for $75 apiece, for a total sale price of $7,500. Your capital gain (long-term, in this case) is $2,500.
Assuming you are married filing jointly, with taxable income of $150,000, your long-term capital gains tax rate would be 15%:
$2,500 (long-term gain) x 0.15 (tax rate) = $375 (capital gains tax payment)
This may vary based on any fees or commissions paid. Remember as well that an increase in value on an investment asset isn’t considered a capital gain until you sell the asset. If you purchase 100 shares of stock at $50 per share, and a year later, the stock is priced at $100 per share, there is no capital gain unless you sell the stock.
That said, you may occasionally receive a capital gain distribution if you own shares in a mutual fund that owns capital assets and sells them at a gain. That gain would be passed to investors in the mutual fund and considered income, reported on Form 1099-DIV.
Capital gains on real estate work slightly differently than capital gains on other assets, and your tax bill will depend on whether the real estate is an investment or your primary residence.
Investment real estate: For any real estate other than your primary residence, you’ll pay capital gains taxes on any profit you realize when you sell the property. If you buy an investment property, such as a rental building for $400,000 and sell it five years later for $475,000, you have a capital gain of $75,000, and you will pay long-term capital gains taxes. If you’ve taken depreciation deductions that lower your cost basis, you’ll also be taxed on the depreciation, through what is known as depreciation recapture.
Owner-occupied real estate: There are different rules that apply to capital gains on your primary residence. The short- and long-term tax rules are the same, but each individual gets a $250,000 exemption on capital gains before they owe any taxes. If you’re a married couple, that means you can exclude up to $500,000 in capital gains when you sell your home. You can only claim this exemption once every two years.
It’s also worth noting that any improvements you’ve made to the home can be added to the basis. So if you bought a home for $200,000 and you’ve done $50,000 worth of home improvements, your new basis for purposes of capital gains calculation is $250,000.
In order for your home to qualify as your primary residence, you must have lived in and used it as your main home for at least two of the previous five years. If this is not the case, you are not eligible for the tax break.
Some people buy and sell collectibles, such as art, coins, antiques or jewelry. Capital gains on collectibles held for more than a year are taxed at a maximum 28% rate, no matter what tax bracket you’re in.
Investors with a high net worth may also experience different capital gains tax rates. People with income over a certain threshold will see their capital gains subject to an additional 3.8% tax. The following people are subject to the additional tax:
|Net Investment Income Tax Thresholds|
|Filing status||Threshold amount|
|Single, or head of household||$200,000|
|Married filing jointly, or qualifying widow(er) with dependent child||$250,000|
|Married filing separately||$125,000|
Using tax loss harvesting strategies and talking to a financial advisor are one way to minimize your capital gains tax exposure. Capital gains taxes can take a big bite out of your investment gains, but there are a few strategies to lower your bottom line:
If you have capital losses — meaning you sold an investment asset for less than you paid for it — you can use those losses to offset your capital gains for tax purposes. If you have $1,000 in capital gains and $1,000 in capital losses, for instance, you have no taxable capital gains. If you have more losses than gains, you can claim up to $3,000 of losses against your taxable income, carrying forward any excess losses to future years.
Tax rates for long-term capital gains are lower than those for short-term capital gains. Holding investments past the one-year mark before selling will automatically result in lower taxes.
You don’t pay taxes on investment gains in a tax-deferred retirement account until you take distributions in retirement, and by then, you may be in a lower tax bracket. If you’re choosing an investment that might result in frequent gains or dividends, a tax-advantaged retirement account can be a good place in which to hold it. For example, you can trade stocks in a retirement account, such as an IRA, without having to worry about paying short-term capital gains.
Charitably inclined? If you itemize deductions on your tax return, you can donate an asset with significant gains to the nonprofit organization of your choice. If you’ve got some low-basis stock that you’ve held for 20 years, you can gift those shares, get a tax benefit and avoid the capital gains you’d otherwise have if you sold it.
If you sell an investment property at a profit but buy another similar property (“like-kind”) soon thereafter, your capital gains on the first property won’t be recognized. You must identify the exchange within 45 days and complete the transaction within 180 days to qualify.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.