Hey everybody! I’m Bette Hochberger, CPA, CGMA, and in today’s quickie, I’ll be discussing capital gains tax. Now, when you sell an asset like stocks, real estate, or even a piece of artwork for more than you paid for it, the profit you make is called a capital gain. The government charges a tax on these profits, known as the capital gains tax.
Understanding how this tax works can help you manage your investments and plan your finances more effectively, so let’s go ahead and dive in!
How Capital Gains Tax Works
What Is a Capital Gain?
A capital gain occurs when you sell an asset for more than what you originally paid for it. For example, if you bought a stock for $1,000 and sold it later for $1,500, your capital gain is $500.
Types of Capital Gains
There are two types of capital gains: short-term and long-term.
– Short-Term Capital Gains: If you hold an asset for one year or less before selling it, the profit is considered a short-term capital gain. These gains are taxed at your regular income tax rate.
– Long-Term Capital Gains: If you hold an asset for more than one year, the profit is considered a long-term capital gain. These gains are taxed at a lower rate, making it more favorable to hold onto investments for a longer period.
How to Calculate Capital Gains Tax
Calculating capital gains tax might seem complicated, but it’s actually quite simple! To calculate the capital gains tax you owe, you need to know these 3 basic things:
– The original purchase price (also known as the cost basis).
– The sale price of the asset.
– The duration for which you held the asset.
The difference between the sale price and the cost basis is your capital gain. Depending on how long you held the asset, this gain will be taxed at either the short-term or long-term rate.
Capital Gains Tax Rates
The tax rate on capital gains depends on your income level and how long you held the asset.
Short-Term Rates
Short-term gains are taxed at the same rate as your ordinary income. This means the tax rate can range from 10% to 37%, depending on your income bracket.
Long-Term Rates
Long-term gains are taxed at lower rates. For most people, the rates are:
– 0% if your income is below a certain threshold.
– 15% if your income falls within the middle brackets.
– 20% if your income is in the highest bracket.
Additionally, it’s important to note that long-term capital gains tax rates can also include a 28% rate for specific assets, such as collectibles. Understanding these various rates is important for comprehensive financial planning. These lower rates make long-term investments more appealing for those looking to minimize their tax burden.
Special Considerations
Exemptions and Deductions
Some assets, like your primary home, may qualify for exemptions. For example, if you sell your home, you might be able to exclude up to $250,000 of capital gains ($500,000 for married couples) from your taxable income.
Capital Losses
If you sell an asset for less than you paid for it, you incur a capital loss. You can use these losses to offset your capital gains, reducing the amount of tax you owe.
State Taxes
In addition to federal capital gains tax, some states also impose their own taxes on capital gains. The rates and rules vary by state, so it’s important to check your state’s regulations.
Understanding how capital gains tax works and the rates you might pay can help you make smarter financial decisions. Whether you’re selling stocks, real estate, or other assets, knowing the tax implications can help you maximize your profits and avoid surprises when tax season comes around.
If you have questions or need help with tax planning, consider scheduling a meeting with us to make sure that you’re making the best choices for your financial situation!
I’ll see you next time!
