With low interest rates and the record inflation affecting almost every part of the economy, increasing numbers of investors are shifting their money out of cash and into assets that can bring a return over time. While many of these investments will bring lucrative returns, not everyone is aware that selling profitable assets means that a portion of the returns must be paid to the government in the form of tax.
Simply put, selling a capital asset for more than its purchase price results in a capital gain, which is taxable. The following assets can all bring capital gains, and consequently capital gains taxes:
- Stocks
- Bonds
- Precious metals
- Jewelry
- Real estate
- Mutual Fund Shares
Holding Period
The capital gains taxes an investor is required to pay are dependent on four main factors: the type of asset, the income of the seller, the seller's filing status, and the holding period.The holding period is defined as the amount of time an investor owns an asset before selling it. Keep in mind that when calculating the holding period, the day an asset is bought does not count toward the actual total holding time. However, the day an asset is sold does count towards the overall time.
For example, if you bought a stock on November 21, 2020, the holding period begins on November 22, 2020. As a result, November 21, 2021 would mark one year of ownership for tax purposes.
Determining the holding period of an asset is important as it allows an investor to see whether they have held the stock for greater than one year, or less than one year, as investors are subject to different capital gains tax rates in each period.Short-Term Capital Gains
Assets that have been sold at a profit, and have been held for one year or less, are subject to short-term capital gains taxes. Short-term assets are taxed at ordinary income tax rates, which can be as high as 37% in 2021 and 2022. Additionally, these assets can also receive an additional 3.8% Medicare surtax depending on the seller's income level. An easy way to think of the short-term capital gains tax is that any income generated by investments held for less than a year is simply added to the taxable income for that year. For example, if you have $90,000 in taxable income from your salary and $10,000 from short-term investments, then your total taxable income is $100,000.Below is a chart detailing the short-term capital gains rates for the 2022 fiscal year. Note that the tax-rate varies according to the seller's income and filing status.
| Tax Rates for Short-Term Capital Gains 2021 | |||||||
|---|---|---|---|---|---|---|---|
| Filing Status | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
| Single | Up to $9,950 | $9,951 to $40,525 | $40,526 to $86,375 | $86,376 to $164,925 | $164,926 to $209,425 | $209,426 to $523,600 | Over $523,600 |
| Head of household | Up to $14,200 | $14,201 to $54,200 | $54,201 to $86,350 | $86,351 to $164,900 | $164,901 to $209,400 | $209,401 to $523,600 | Over $523,600 |
| Married filing jointly | Up to $19,900 | $19,901 to $81,050 | $81,051 to $172,750 | $172,751 to $329,850 | $329,851 to $418,850 | $418,851 to $628,300 | Over $628,300 |
| Married filing separately | Up to $9,950 | $9,951 to $40,525 | $40,526 to $86,375 | $86,376 to $164,925 | $164,926 to $209,425 | $209,426 to $314,150 | Over $314,150 |
Long-Term Capital Gains
Long-term gains are taxed at a much lower rate by the federal government, which is the main reason many investors attempt to hold onto their investment for at least a year.Below is a chart detailing the long-term capital gains rates for fiscal 2022. Note that some individuals are not required to pay capital gains tax depending on their income and filing status.
| Tax Rates for Long-Term Capital Gains 2021 | |||
|---|---|---|---|
| Filing Status | 0% rate | 15% rate | 20% rate |
| Single | Up to $40,400 | $40,401 to to $445,850 | Over $445,850 |
| Head of household | Up to $54,100 | $54,101 to $473,750 | Over $473,750 |
| Married filing jointly | Up to $80,800 | $80,801 to $501,600 | Over $501,600 |
| Married filing separately | Up to $40,400 | $40,401 to $250,800 | Over $250,800 |
Some Exceptions
Collectibles
It's important to note that the IRS considers collectibles to be "alternative investments" and applies a special tax rate to these objects. Collectibles include items such as art, stamps, coins, cards, comics, rare items and antiques.Collectibles are taxed at a hefty 28%, with some sellers subject to a 3.8% net investment income tax depending on gross income. The rate for collectibles is considerably higher than the tax rate on most long-term capital gains, which is an average of 15% for most taxpayers.
Real Estate
Real estate is a unique investment in that it is subject to a special capital gains arrangement.If an owner sells his house, and has lived in the residence for two of the five years leading up to the sale, then the first $250,000 of the owner's capital gains on the sale is excluded from taxable income ($500,000 for those married filing jointly).
However, if the home is sold for less than the owner paid for it, this loss is not considered tax-deductible because personal property capital losses are not tax-deductible.Stock Sales (Under 19)
Additionally, in the rare scenario that children under 19 years of age achieve long-term stock sales (under age 24 if they are students), these individuals do not qualify for the 0% rate.In this scenario, the child’s gains would be taxed at the parents’ higher rates.
States and Capital Gains Taxes
In addition to the federal capital gains tax rates discussed earlier, individuals must pay capital gains taxes which vary according to where they live.Not all states are created equal when it comes to capital gains taxes. While most states have capital gains taxes, some states, such as the ones listed below, have no capital gains taxes:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Some states, such as Colorado and New Mexico, offer exclusions or deductions on federally taxed gains.
Carryover of Losses
As almost all investors have multiple assets that generate different returns, one of the most common investing strategies to reduce the tax burden is to use losses to balance out positive returns. This is known as "tax-loss harvesting" or "carrying over losses."For example, if you are holding a stock that has lost most of its value and you are confident will not recover, you should wait until you have an asset with a sizable return until you sell. Selling a losing asset in the same fiscal year as a profitable asset allows an investor to offset the gain he has earned.