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Anytime you sell an asset, such as stocks, bonds, real estate or even your car, you may have to pay capital gains tax on the profit. Because capital gains taxes can substantially impact the value of your investment portfolio overall, it's wise to account for taxes in your investment strategy.
Here's how to know if you'll have to pay capital gains tax, how to calculate what you'll owe and steps you can take to reduce or defer gains tax.
When You Have to Pay Capital Gains Tax
Anytime you sell a capital asset for more than you paid for it, you've realized a capital gain. If you sell a capital asset for less than what you paid, you've realized a loss and may be able to deduct it from your taxes.
Assets such as stocks that gain value but remain in your possession aren't taxed as long as you continue to hold on to them. Once you sell the asset, you've realized the gain and you'll need to report your gain or loss to the IRS and may be required to pay capital gains tax.
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What Counts as a Capital Asset?
As far as the IRS is concerned, "Almost everything you own and use for personal or investment purposes is a capital asset." Whether you bought an asset with investing in mind or to get use out of, such as a car, you should prepare yourself for the possibility of paying tax on your profit when you sell it.
Common examples of capital assets include:
- Stocks
- Bonds
- Exchange-traded funds
- Mutual funds
- Index funds
- Cryptocurrency
- Real estate
- Vehicles
- Boats
- Jewelry
- Collectibles
Note that certain capital assets are subject to specific tax rules, so it's always best to consult with a tax professional who understands the specifics of your tax liability. For example, collectibles such as stamps and artwork are subject to a maximum tax rate of 28%.
How Much Capital Gains Tax Do You Have to Pay?
It's always advisable to work with a certified public accountant or other tax professional to ensure your taxes are all in order, but crunching the numbers beforehand can help you factor tax implications into your investing strategy. To understand how much you'll owe in capital gains tax, first calculate your capital gains:
Capital Gains = Amount Realized - Cost Basis
The amount realized is how much you sold the asset for, minus any expenses related to the sale, such as sales commissions.
The cost basis is the asset's original purchase price, plus any commissions or fees you pay to buy the asset.
Here's an example: Joan buys stock of Company XYZ at a cost basis of $3,000. After a couple years, the market value of her position has increased to $4,000 and Joan decides to sell her stocks. She's realized a capital gain of $1,000 ($4,000 - $3,000 = $1,000).
Because she held on to the stocks for several years, her tax rate will be assessed as a long-term capital gain. Let's go over what that means to determine how much she would owe.
Understanding Short-Term and Long-Term Capital Gains
To determine how much capital gains tax you'll owe on the profits from selling an asset, you'll need to determine whether your gains are short term or long term.
- Short-term investment: If you sell an asset within one year of buying it, your gain or loss is considered short term. A net short-term gain is subject to tax at your ordinary income tax bracket.
- Long-term investment: If you sell the asset after one year of buying it, your gains are considered long term. Net long-term gain may be subject to a lower long-term asset tax rate, and most earners won't pay more than 15% in capital gains tax.
| Long-Term Capital Gains Tax Rates for 2021 Tax Year | ||||
|---|---|---|---|---|
| Rate | Single | Married, filing jointly | Married, filing separately | Head of household |
| 0% | Up to $40,400 | Up to $80,800 | Up to $40,400 | Up to $54,100 |
| 15% | $40,401 - $445,850 | $80,801 - $501,600 | $40,401 - $250,800 | $54,101 - $473,750 |
| 20% | Over $445,850 | Over $501,600 | Over $250,800 | Over $473,750 |
Source: IRS
| Long-Term Capital Gains Tax Rates for 2022 Tax Year | ||||
|---|---|---|---|---|
| Rate | Single | Married, filing jointly | Married, filing separately | Head of household |
| 0% | Up to $41,675 | Up to $83,350 | Up to $41,675 | Up to $55,800 |
| 15% | $41,676 - $459,750 | $83,351 - $517,200 | $41,676 - $258,600 | $55,801 - $488,500 |
| 20% | Over $459,750 | Over $517,200 | Over $258,600 | Over $488,500 |
Source: IRS
Continuing with the example above, if Joan made $75,000 in 2021 and filed taxes as a single person, she would fall into the 15% marginal tax bracket. That means she would owe $150 in federal taxes on her long-term capital gain of $1,000 (not including any applicable state taxes).
Four Ways to Minimize Capital Gains Tax
There are four main ways to minimize, defer or sometimes entirely avoid taxes on your capital gains.
1. Hold the Asset
Regardless of whether your asset has increased in value, your gains remain unrealized until you sell. If an asset is stable in value or growing steadily, it could be in your favor to hold it for more than one year to benefit from lower capital gains taxes. Of course, with riskier assets, the potential for loss may play a large part in your holding strategy.
2. Maximize Tax-Advantaged Investing
Investing through a 401(k) or IRA allows you to defer paying taxes on your gains until retirement. When you do retire, your withdrawals will be taxed as regular income.
Of course, this means you won't benefit from reduced long-term investment taxes, but it's likely that you'll be in a lower income tax bracket in retirement than you are now, and your wealth will continue to grow tax-free in the meantime.
3. Report Your Losses
If you've taken a loss on stocks or other assets this year, you may be surprised to hear that those losses can benefit you by offsetting your net capital gain, thereby potentially lowering what you'll pay in taxes.
If your losses are greater than your capital gains for that year, you may be able to use up to $3,000 of your remaining loss to offset your income dollar-per-dollar. You can also carry over losses to decrease your taxable income next year if you reach the deduction limit for the current tax year.
4. Claim an Exclusion of Gain
Are you selling your home? If so, you may qualify to exclude up to $250,000 (or $500,000 if you're married) from your taxable profit. If you realized less than $250,000 in profits from the sale of your home, you may not be required to pay taxes on the sale at all.
You'll need to meet certain conditions to qualify for the gain, such as living in the home as your primary residence for at least two years in the five-year period preceding the sale. IRS Publication 523, Selling Your Home, provides a list of eligibility requirements.
Plan Ahead for Taxes
Starting to invest with taxes in mind can help you build wealth faster and get more out of your portfolio. Remember that anytime you sell a capital asset, you may be required to pay capital gains taxes. Until you sell, your gains are unrealized. And it's often in your favor to avoid short-term taxes by being mindful of an asset's holding period and by using a tax-advantaged retirement account.
Taxes can be complicated, so even seasoned investors often enlist professional help from accountants and financial planners to confidently figure their taxes and maximize deductions. If you sold stocks, bonds, cryptocurrency or other assets this year, consider reaching out to an accountant for help.