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Updated on Tuesday, November 10, 2020
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.
- What are capital gains?
- Short-term vs. long-term capital gains tax
- How to calculate capital gains taxes
- Exceptions to typical capital gains tax rates
- 5 ways to minimize or avoid capital gains tax
What are capital gains?
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.
Short-term vs. long-term capital gains tax
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.
- Short-term capital gains tax: These gains are taxed as ordinary income, so they will be taxed in whatever federal income tax bracket you fall into.
- Long-term capital gains tax: These gains are taxed at either 0%, 15% or 20%, depending on your annual income.
Short-term capital gains rates
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|
Long-term capital gains rates
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|
How to calculate capital gains taxes
Calculating your capital gains isn’t too complicated. Here’s how it works:
- Consider how long you’ve held the asset: Figuring this out will help you determine whether it should be taxed as a long-term or short-term capital gain.
- Figure your basis: This will typically be the purchase price plus any fees or commissions you paid for the asset.
- Figure your realized amount: This will be the sales price less any fees or commissions paid.
- Subtract one from the other: Subtract what you paid from your sales price to get the difference between the two numbers. If you sold the asset for more than you paid for it, this is a capital gain. If you sold the asset for less than you paid for it, it’s a capital loss.
- Find your tax rate: Based on whether it’s a short- or long-term capital gain, find your tax rate based on your taxable income and the tables above.
- Apply the tax rate to your gain: Multiply your capital gain by your tax percentage to determine how much tax you’ll pay on the proceeds.
An example of how capital gains taxes are calculated
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.
Exceptions to typical capital gains tax rates
Capital gains on real estate
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.
Capital gains on collectibles
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.
Net investment income tax
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|
5 ways to minimize or avoid capital gains tax
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:
1. Use capital losses
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.
2. Hold your investments
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.
3. Take advantage of tax-deferred accounts
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.
4. Gift your winners
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.
5. Execute a like-kind exchange
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.