If you held the investment for less than a year, your short-term gain will be taxed at ordinary income tax rates. If you sold the asset after holding on to it for more than a year, you would be taxed a long-term capital gains tax based on your income. For 2022, long-term capital gains tax rate varies between 0% for individuals earning up to $41,675 ($44,625 for 2023) and 20% for single filers making more than $459,750 ($492,300 for 2023). Certain collectible assets may attract a 28% capital gains tax.
How Are Capital Gains Calculated?
Capital gains tax is paid on the difference between a capital asset’s adjusted basis and the amount for which you sell it. Let’s understand those concepts.
What Is A Capital Asset?
Capital assets are investments such as stocks, mutual funds, bonds, real estate, precious metals, coins, fine art, and other collectibles. You’re taxed on the change in value if your investment has an increase in value when a capital asset is sold. Investments can also produce income in the form of interest, dividends, rents, and royalties. This is taxed as income as it’s generated and isn’t considered to be a capital gain.
Cost Basis and Adjusted Basis
Cost basis is the original price you pay for a capital asset, plus any associated costs, such as commissions paid to brokers. An asset’s cost basis must be adjusted up or down to reflect its true cost for tax purposes in some cases. This is referred to as an “adjusted basis,” and it’s calculated by beginning with the original cost basis, then making adjustments that either increase or decrease that basis. Suppose you bought that $50 share of stock and paid $1.25 in fees. Your adjusted basis would be $51.25. Now suppose that one year later, you sold that same share of stock for $70. Your capital gain is the difference between $51.25 and $70, or $18.75. You’d paid capital gains tax on the $18.75.
Short-Term vs. Long-Term Capital Gains
A short-term capital gain occurs when you hold an asset for one year or less, then sell for a profit. Suppose you buy stock in your favorite company. The stock’s price goes up a few months later, and you decide to sell your shares to lock in your gains. The money you make is considered a short-term capital gain because you held the stock for less than one year. A long-term capital gain occurs when you sell for a profit after holding an asset for more than one year. Selling for a profit would result in a long-term capital gain if you had purchased that same stock of your favorite company, but you held onto your shares for a few years rather than a few months. Short-term gains are taxed at ordinary income tax rates according to your tax bracket. Long-term capital gains are taxed at their own long-term capital gains rates, which are less than most ordinary tax rates. The long-term capital gains tax rate is either 0%, 15%, or 20%, depending on your overall taxable income. Some other types of assets might be taxed at a higher rate. Buy-and-hold investing is a common example of when you might pay long-term capital gains taxes or not pay them, depending on your income. People who use this strategy often put their money into investments such as index funds or exchange-traded funds (ETFs), then hold them for long periods, often many years. Any profits you’ve made could be subject to long-term capital gains when you ultimately sell your investments.
2022-2023 Capital Gains Tax Rates
Long-Term Capital Gains Tax Rates for Tax Year 2022
Single taxpayers and those who are married and filing separate returns won’t pay a capital gains tax if their income was below $41,675 in 2022. The threshold is slightly higher for heads of household and twice as much for married couples filing jointly. Only single people who made more than $459,750 and married couples who earned more than $517,200 or more in 2022 will pay the highest capital gains tax rate.
Short-Term Capital Gains Tax Rates For 2022
Unlike long-term capital gains, short-term gains are taxed as ordinary, or regular, income. You can expect to pay taxes on those gains at the same rate you’d pay in income taxes as a result. You could pay anywhere from 10% to 37% on those gains, depending on how much you earn.
How To Minimize Capital Gains Taxes
You can minimize capital gains taxes using a few strategies.
Hold Your Investments Longer
The long-term capital gains tax rate is usually lower than the rate for short-term capital gains. An individual making up to $41,000 in taxable income, or a married couple making up to $83,000, will pay no taxes at all on a long-term capital gain in 2022. These same people would pay up to 12% for a short-term capital gain. And the difference could be 20% for long-term capital gains versus 37% for short-term capital gains earned in tax year 2022 for very high earners.
Invest in Tax-Advantaged Retirement Accounts
Tax-advantaged retirement accounts such as 401(k)s and individual retirement accounts (IRAs) aren’t subject to the same capital gains taxes as other investments. You can buy and sell assets within these accounts without worrying about paying a capital gains tax. These tax-advantaged rules also apply to 529 college savings plans.
Take Advantage of Tax Loss Harvesting
Tax loss harvesting is a strategy that involves selling securities at a loss to offset the amount of the gain you realized on other investments that you sold. This strategy helps reduce your overall tax liability because the loss can help cancel out the gain. Suppose you invest $1,000 in Fund A and $1,000 in Fund B. One year later, you sell Fund A at $1,300 and Fund B at $500. You realized a gain of $300 with Fund A and a loss of $500 with Fund B. You wouldn’t owe any tax on the gain, because you lost more than you gained. That amount can also help you reduce your taxable income.
Claim Your Capital Losses
The IRS allows you to claim your capital losses up to a certain amount and use them to offset your capital gains. A capital loss occurs when you sell an asset for less than what you paid for it. Be sure to claim any losses to help reduce your capital gains tax burden when you file your tax return. You can also claim up to $3,000 or $1,500 (if married filing separately) in capital losses as a tax deduction for the 2022 tax year —the return you’d file in 2023. You can carry any unused balance forward to subsequent tax years if your losses exceed this amount. This is subject to a host of rules, however. For example, if you incurred a $10,000 loss this year but also realized capital gains of $2,000 on your stock portfolio, you could offset that gain against your loss as well as claim $3,000 ($1,500 if married filing separately) as a capital loss deduction. You’d be able to carry forward and claim the remaining $5,000 as capital loss deduction in future years. Tax planning for investors focuses on deferring the sale of profitable investments until you qualify for the discounted long-term capital gains tax rate.
Pay Attention to Your Income
The rate at which a long-term capital gain is taxed depends on your income for the year. Consider holding the asset until a year when your income might be lower if your income is right over the limit of a capital gains tax bracket. Just a small change in your income can make a pretty significant difference. Someone making $41,000 in taxable income might not pay any long-term capital gains taxes at all, while someone with $42,000 in taxable income would pay 15% in long-term capital gains taxes. Consider finding other ways to reduce your taxable income, such as looking for deductions you might qualify for, if you don’t anticipate your income going down in the future. Slightly increasing your deductible contributions to a retirement account may reduce your taxable income enough to bring you down to a lower long-term capital gains tax rate.
Unusual Capital Gains Situations
While the short-term and long-term capital gains rules apply to many investments, there are a handful of exceptions.
Capital Gains on Mutual Funds
Capital gains apply slightly differently to mutual funds. Unlike other types of assets, you might be subject to capital gains taxes for your mutual fund holdings even if you don’t sell your shares. Mutual fund companies must pass earnings on to shareholders in the form of distributions throughout the year. You’ll still have to report and pay capital gains taxes on them even if you reinvest your distributions back into the fund.
Capital Gains on your Primary Residence
The IRS offers a capital gains exclusion to homeowners who are selling their primary residences. Be sure to take advantage of the exclusion amount when filing your taxes if you sell your home for more than you paid for it. You can exclude the first $250,000 (or $500,000 for married couples) of your capital gain from taxes if:
You owned the home for at least two of the past five years.You owned the home and used it as your residence for at least two of the past five years.You didn’t sell another home during the two years before the date of sale or didn’t take an exclusion from the sale.
Capital Gains on Collectibles
The tax rate on capital gains from the sale of collectibles is 28%. Collectibles include:
StampsCoinsPrecious metalsPrecious gemsRare rugsAntiquesAlcoholic beveragesFine art
Capital Gains on Depreciated Property
The IRS taxes unrecaptured Section 1250 gains at a rate of 25%. This section of the tax code applies to property you own that has depreciated in value over time, resulting in a tax break.
Capital Gains on Small Business Stock
You’ll be taxed at a rate of 28% if you sell qualified small business stock and receive a capital gain.
Net Investment Income Tax
You might also be subject to the net investment income tax (NIIT), depending on your annual income. This rule results in an additional 3.8% tax on certain investment income for single filers with modified adjusted gross incomes (MAGIs) of $200,000 or more, and married individuals filing jointly with MAGIs of $250,000 or more.
