Capital Gains Tax
Capital gains are the profits you make when you sell a stock, real estate or other taxable asset that increased in value while you owned it. The capital gains tax is based on that profit. The long-term capital gains tax rate is typically 0%, 15% or 20%, depending on your tax bracket. You do not have to pay capital gains tax until you’ve sold your investment.
Capital gains taxes apply to the sale of stocks, real estate, mutual funds and other capital assets. The tax is based on the profit you made — the price you sold it for minus the price you paid — and how long you held onto the asset.
The long-term capital gains tax rate, for assets held for more than one year, depends upon your taxable income. Short-term capital gains rates are higher and are based on your income tax bracket.
What Is Capital Gains Tax?
A capital gains tax is a tax you pay on the profit made from selling an investment.
You don’t have to pay capital gains tax until you sell your investment. The tax paid covers the amount of profit — the capital gain — you made between the purchase price and sale price of the stock, real estate or other asset. When you sell, your gain (or loss) is referred to as “realized.” Conversely, unrealized gains and losses occur when you have yet to officially sell the investment.
How much you pay in taxes depends in part upon whether you made a short-term or long-term capital gain on your investment, and each is taxed in different ways.
- Short-Term Capital Gain
- Short-term capital gains tax rates apply to assets you sell in one year or less of owning them.
- Long-Term Capital Gain
- Long-term capital gains tax rates apply to assets you sell after one year of owning them.
Short-term capital gains are taxed as ordinary income, such as the income tax you pay on your salary, at your standard federal income tax rate. This tends to be a higher rate than for long-term capital gains taxes, which are based on defined tax brackets that are adjusted each year for inflation.
Capital Gains Tax Rates for 2021
The capital gains tax on most net gains is no more than 15% for most people. If your taxable income is less than $80,000, some or all of your net gain may even be taxed at 0%.
As of 2021, the long-term capital gains tax is typically either 0%, 15% or 20%, depending upon your tax bracket. This percentage will generally be less than your income tax rate.
2021 Long-Term Capital Gains Tax Rates Based on Taxable Incomes
There are some exceptions to this “0-15-20%” rule which allows certain capital gains to be taxed at higher rates.
- Taxable portions of the sale of certain small business stocks are taxed at a 28% maximum rate.
- Net capital gains from selling collectibles such as coins or art are taxed at a 28% maximum rate.
- Certain portions of capital gains from specific real estate sales are taxed at a 25% maximum rate.
Source: Internal Revenue Service
How Are Capital Gains Calculated?
Capital gains and losses are calculated by subtracting the amount you paid for an asset from the amount you sold it for.
If the selling price was lower than what you had paid for the asset originally, then it is a capital loss.
You can then use this amount to calculate your capital gains tax.
You may also use an online capital gains tax calculator to estimate what your taxes might be. Most calculators you find online will only give you an estimate of your tax liability. It is recommended to consult with a professional tax advisor or tax software to arrive at your actual tax liability.
How to Reduce Your Capital Gains Tax Bill
There are several ways to legally reduce your capital gains tax bill, and much of the strategy has to do with timing.
- Claim your losses.
- You can deduct up to $3,000 in investment losses from your investment profits every year. If you’ve bought an investment that’s losing money, you can sell it before the end of the year to cut your tax bill.
- Don't buy back losing investments.
- If you sell a losing investment to take advantage of a tax deduction, don’t turn around and buy it right back after the first of the year. If you do that within 30 days of selling, you can be penalized by the IRS.
- Invest in a retirement plan.
- The money you invest in a 401(k), individual retirement account (IRA) or similar retirement plan is not subject to capital gains taxes after you retire.
- Take advantage of retirement.
- Wait until you retire to sell your profitable investments. If you have a lower income in retirement, it can lower your capital gains tax rate. If the rate is low enough, you may not have to pay any capital gains taxes at all.
- Track your qualifying expenses.
- Depending on your investing habits, some maintenance expenses may qualify as tax deductions. Keeping track of these qualified expenses can reduce your capital gains tax bill.
- Wait more than one year.
- If you sell your investment before you’ve held it for one year, the gain is counted as regular income and is taxed at a higher rate. Holding onto the asset for more than one year will let you take advantage of the lower capital gains tax rates. Talking with a professional tax advisor can help you take full advantage of strategies to legally reduce your capital gains tax bill. They can also help you maximize your tax advantages with the best approach for you and your overall personal finance strategy.
- Donate to charity.
- You can use charitable contributions to offset your capital gains taxes. By donating highly appreciated stocks and other assets to charity, you can minimize capital gains liabilities and deduct the fair market value of what you donated from your income taxes.
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- Internal Revenue Service. (2021, October 25). Topic No. 409 Capital Gains and Losses. Retrieved from https://www.irs.gov/taxtopics/tc409
- Internal Revenue Service. (2021, October 25). Topic No. 701 Sale of Your Home. Retrieved from https://www.irs.gov/taxtopics/tc701
- Mengle, R. (2021, June 15). What Are the Capital Gains Tax Rates for 2021 vs. 2020? Retrieved from https://www.kiplinger.com/taxes/capital-gains-tax/602224/capital-gains-tax-rates-for-2021-vs-2020
- U.S. Congressional Research Service. (2021, June 4). Tax Treatment of Capital Gains at Death. Retrieved from https://crsreports.congress.gov/product/pdf/IF/IF11812
- York, E. (2019, April 16). An Overview of Capital Gains Taxes. Retrieved from https://taxfoundation.org/capital-gains-taxes/