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?
Capital gains tax is a tax on profits from selling investments like stocks or real estate.
It’s calculated based on the difference between the purchase and sale price, which is also known as the capital gain. This tax applies when the gain is realized through the actual sale. Unrealized gains or losses occur when the investment hasn’t been sold yet.
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 vs. Long-Term Capital Gains Taxes
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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 2023
The capital gains tax on most net gains is no more than 15% for most people. If your taxable income is less than $89,250 as a married couple filing jointly, some or all of your net gain may even be taxed at 0%.
As of 2023, 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.
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2023 Long-Term Capital Gains Tax Rates Based on Taxable Incomes
|Capital Gains Tax Rate||Single||Married Filed Separately||Head of Household||Married Filed Jointly|
|0%||Up to $44,625||Up to $44,625||Up to $59,750||Up to $89,250|
|15%||$44,626 to $492,300||$44,626 to $276,900||$59,751 to $523,050||$89,251 to $553,850|
|20%||$492,300 and higher||$276,900 and higher||$523,050 and higher||$553,850 and higher|
There are some exceptions to this “0-15-20%” rule which allows certain capital gains to be taxed at higher rates.
Higher Capital Gains Tax Rate Exceptions
- 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
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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.
Asset Selling Price – Price You Originally Paid for the Asset = Capital Gain (or Loss)
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.
Steps to Calculate Your Capital Gains Tax
- Separate your short-term and long-term capital gains (because they are taxed in different ways.)
- Total your short term capital gains and losses, adding and subtracting to get your net gain or loss.
- Use tax preparation software – or go to your tax preparer – to determine your tax liability.
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.
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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.
Strategies to Reduce Your Capital Gains Tax Liability