Capital Gains Tax Rate and Rules 2021 – Mitigating Your Tax Liability

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Updated on Thursday, December 10, 2020

As an investor, the goal is to improve the performance of your portfolio and make money through capital gains. However, when you see gains from your investments, the United States government expects to get its cut in the form of taxes, known as capital gains tax. Here’s what you need to know about the capital gains tax rate and when you’re expected to pay.

Capital gains tax rates 2021

In general, capital gains (or losses) are realized when you sell an investment. Short-term capital gains are those that come from the sale of investments that you’ve held for a year or less. These gains are considered part of your income and taxed at your marginal tax rate.

Long-term capital gains, on the other hand, are realized on investments that you’ve held for more than a year. If you bought an asset a year and a day ago, you can access a favorable capital gains tax rate. Here are the federal capital gains tax rates for 2021:

2021 Long-Term Capital Gains Tax Rates for Single Filers

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2021 Long-Term Capital Gains Tax Rates for Those Married, Filing Jointly

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2021 Long-Term Capital Gains Tax Rates for Those Married, Filing Separately

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2021 Long-Term Capital Gains Tax Rates for Head of Household

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As you may have noted from looking at the above tax brackets, even at the highest capital gains tax rate, it’s likely that you’ll still pay less on your investment gains than you do on your regular earned income. That’s because capital gains tax brackets are designed to reward those who invest for the longer term.

What counts as a capital gain?

A capital gain is what’s realized on an asset that increases in value. With a stock, your capital gains are realized when you sell a share for more than you bought it for. The same is true of an asset like real estate. If you sell a piece of property for more than your purchase price, the difference is your gain.

Basically, you used your money (your capital) to buy an asset. When that asset becomes worth more, and you sell it for a higher price, you receive more capital (money). If you held that asset for more than a year, you’ll see long-term versus short-term capital gains.

How to calculate capital gains taxes

Calculating your federal capital gains tax is fairly straightforward. In essence, it consists of these three steps:

  • Figure out how long you’ve held the asset: Your first step is to figure out how long you’ve had your investment. If you bought it less than a year ago, it’s going to be a short-term capital gain, and you’ll just pay taxes on it at your regular income tax rate.
  • Use the tax table to see how much you’ll owe: If you’ve had the asset for more than a year, you can use a tax table to see how much you’ll owe, based on your income.
  • Multiply your rate by your gain: If you had a gain of $3,000 and you’re in the 15% bracket for long-term capital gains taxes, you simply multiply those together and your tax payment is $450.

In addition to these simple steps, though, there are a few other things you’ll need to consider as you figure out your tax requirement:

Keep cost basis in mind

Your gain is based on the cost basis of an investment. For example, if you buy 10 shares of stock at $100 a piece, you’re paying $1,000. However, if you pay a $7 trading commission on the transaction, that’s added in, bringing your actual cost basis to $1,007.

More than a year later, let’s say you decide to sell all of your shares for $1,500. By this time, though, your broker now offers fee-free trading, so you don’t have to pay a commission. All you have to do is subtract your cost basis, $1,007, from your total sale of $1,500. The result is a gain of $493. That’s the amount you’ll be taxed on, as your capital gains tax is only levied on what you actually made on the transaction.

Use the first in, first out rule

If you’re using a robo-advisor or broker and decide to sell some assets, you might want to make sure that you’re selling your older shares first. There’s a decent chance you won’t sell everything at once. Instead, you might be trying to liquidate a few shares to meet a specific goal. The good news is that most brokers and robo-advisors will automatically sell your oldest shares first. A financial advisor can also help strategize a way to minimize these taxes. When opening an account, you might be asked if you want to use the first in, first out method when deciding which shares to sell and this can be a good plan.

At the end of the year, when sending your tax information, your broker will provide you with your cost basis and gains — and let you know whether they’re long-term versus short-term capital gains. This can help you keep track of the situation.

Remember you can offset capital gains with losses

Realize, too, that you can offset your capital gains with capital losses. If you lose money on investments, that amount can be used to reduce your gains. For example, let’s say you had a gain of $493. However, you had a different investment that you sold at a loss of $800. You can take that $800 loss and use it to offset your $493 gain. Now, instead of owing taxes on $493, you have a loss of $307 that can be deducted from your income.

When calculating your capital gains taxes, you should start by using short-term losses to offset short-term gains, and match long-term losses with long-term gains. Then, taxes are figured on any gains you have, based on whether they’re short-term or long-term.

Be aware of common exceptions for federal capital gains tax

There are some exceptions to keep in mind, depending on the asset. Two common capital gains tax items to be aware of include:

  • Collectibles: Collectibles, art and certain coins are taxed at ordinary income rates up to 28%, regardless of how long you’ve held them.
  • Primary residence: If you have a primary residence and you meet certain conditions (like living in the property for at least two of the last five years before the sale), you can exclude up to $500,000 of your gains from taxes if you’re married and $250,000 if you’re single.

5 strategies to minimize capital gains taxes

When preparing to sell investments, it’s a good idea to know how to reduce your tax bill. Here are some strategies that investors can use to minimize the capital gains tax rate.

1. Don’t sell

You don’t actually pay taxes on your capital gains until you realize them by selling the asset. So, if you can hold off selling, you can reduce your tax bill.

Consider using a strategy that allows you to invest in assets that have long-term staying power, like a strong individual stock or an index fund that reflects broader market trends. If you can invest in a way that allows you to put off selling until you’re ready to accomplish a specific goal, you can reduce the taxes you pay. This is especially true if you can hold off until you’ll be in a lower tax bracket.

2. Invest in tax-advantaged vehicles

You can shelter some of your capital gains from taxes with the help of tax-advantaged accounts. If you have a retirement account, you can sell assets in the account and buy different assets without worrying about capital gains. Later, when you withdraw money from your traditional 401(k) or IRA, you pay taxes on the withdrawals at your regular income tax rate.

If you use a tax-advantaged vehicle like a Roth account, though, you can avoid paying capital gains taxes at all. With a Roth account, you make contributions with after-tax money, but all of your gains grow tax-free. When you withdraw during retirement, you don’t pay taxes on the money.

You can also use a similar strategy with a Health Savings Account (HSA). If you qualify, you can put money into an HSA and invest it. As long as the money is used for eligible healthcare costs, you can withdraw the money tax-free and you won’t have to pay capital gains taxes.

3. Use a tax-matching strategy

When you know you’re going to have a gain that’s taxable, you can offset it by selling a losing investment. Whether you’re rebalancing or hoping to cut losses on an asset that keeps dropping in value, you can take advantage of that loss through a process called tax loss harvesting. You sell at a loss and then use that loss to offset some of your gains.

You reduce the size of your gains with this strategy, and also reduce the capital gains taxes you pay. It’s also possible to use up to $3,000 in excess losses as a deduction against your regular income and carry forward any remaining losses to another year.

4. Donate appreciated property to charity

Rather than cashing out an investment, consider donating it to charity. The charity gets a valuable asset, and you can claim a tax deduction for the value of the asset. It’s treated like a cash donation for tax deduction purposes, and you don’t end up paying taxes on the gain. Plus, you still have the cash you would have donated.

5. Strategically balance gains and losses

Rather than planning on carrying losses into the next year, or waiting until tax time to benefit, you can balance your gains and losses by selling some securities at a loss and some at a gain, based on your needs. If you want to unload a losing stock, you can do so, and instead of waiting until tax time to claim the deduction, look for a profitable stock you planned to sell anyway. Now you have the cash available, and you won’t have to pay a capital gains tax.

By paying attention to the tax impact of your investment transactions, you can make better choices and reduce the amount you pay in federal capital gains tax.

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