If you are trying to calculate capital gains tax for the first time, it can seem daunting. It also changes yearly, making it even more confusing because calculating the tax changes slightly depending on the year.
For years 2021 and 2022, though, it stayed the same. The capital gains tax rate is 0%, 15%, or 20% on most assets that are held for longer than a year. If you have the asset for a year or less, it corresponds to ordinary income tax brackets of 10%, 12%, 22%, 24%, 32%, 35%, or 37%.
What Is Capital Gains Tax?
A capital gains tax is a tax investors pay on the profit they make from an asset’s sale. How much capital gains tax you will pay depends on how long the asset was held before selling, your filing status, and your taxable income.
Capital gains taxes are applied to investments, including stocks, boats, cars, real estate, bonds, or cryptocurrency. Capital gains taxes can also be applied to many different tangible items. The holding period of the asset also determines how much taxes you will owe, and the holding period is the time between the purchase of the asset and the sale.
Short-term capital gains are assets that are held for a year or less, while long-term capital gains are held for longer than a year.
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How Does Capital Gains Tax Work?
The only assets that are used to determine your capital gains tax are assets that have been sold for profit. This means the assets are not being taxed until you have sold them. This allows investors to let their investments grow in value before selling them.
Holding onto an asset can also allow you to pay fewer taxes since they are taxed at more favorable terms than if you had a short-term asset.
Here are some things to keep in mind when learning about capital gains taxes work:
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Investment capital losses can be used to offset gains. So, if you sell a stock for $12,000 but you sell another at a $3,000 loss, then you will be taxed on only $9,000.
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The taxes you owe on the capital gains are due for the year you made the sale. So, if you make a sale in 2022, you will be taxed for it in 2023. Make sure to plan ahead for the tax.
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Capital gains taxes are progressive, just like income taxes.
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Net capital gain is the difference between capital gains and your capital losses for that tax year. You have a net capital loss if your losses are more than your gains. You can use the loss to offset your income by up to $3,000, and any additional losses can be used to offset your income in future years.
Capital Gains Tax Rates In 2021
You can expect these capital gains tax rates for the taxes filed in April 2022 or October 2022 if you have an extension.
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0% Tax rate: $0 to $40,400 for singles, $0 to $80,800 for married filing jointly, $0 to $40,400 for married filing separately, $0 to $54,100 for head of household
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15% Tax rate: $40, 401 t0 $445, 850 for singles, $80, 801 to $501,600 for married filing jointly, $40,401 to $250,800 for married filing separately, and $0 t0 $54,100 for head of household.
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20% tax rate: $445,851 or more for singles, $501,601 or more for married filing jointly, $250,801 or more for married filing separately, and $473,751 or more for head of household.
Capital Gains Tax Rates In 2022
These are the capital gain taxes you can expect to pay in April 2023:
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0% tax rate: $0 to $41,675 for singles, $0 to $83,350 for married filing jointly, $0 to $41,675 for married filing separately, $0 to $55,800 for head of household.
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15% tax rate: $41,676 to $459,750 for singles, $83,351 to $517,200 for married filing jointly, $41, 676 to $258,600 for married filing jointly, and $55,801 to $488,500 for head of household
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20% tax rate: $459,751 or more for singles, $517,201 or more for married filing jointly, $258,601 for married filing separately, and $488,501 or more for head of household.
Long-Term Vs. Short-Term Capital Gains
Knowing the difference between long-term and short-term capital gains is important because it lets you know when to sell an asset or hold onto it for a little longer. The tax you pay on your capital gains will depend on how long you have had the asset, and they are classified as either long-term or short-term.
Remember that any profits you make from an asset sale are taxable. Sometimes selling an asset might not be a good idea, while other times, it can make you a good chunk of money if you have held onto the asset for a long time.
Long-term capital gains come from assets that are held for more than a year before they are sold. Long-term assets are taxed at the same thresholds of taxable income of 0%, 15%, or 20%. Most people pay a tax of 15% or lower than it comes to capital gains taxes.
Short-term capital gains are taxed like ordinary income, which can be up to 37% depending on what tax bracket you fall into. This means you could potentially pay a significant tax on short-term assets if you have a large income. This is why some people find it better to hold onto assets if you can.
Key Differences
Knowing the key differences between short-term and long-term capital gains taxes is very important. Here are some things to keep in mind when learning about the differences:
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Capital assets include tangible and nontangible items, including stocks, precious metals, real estate, bonds, and jewelry.
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For art, antiques, jewelry, precious metals, stamp collections, and cons, there is a flat 28% capital gains tax regardless of your income. This applies to most collectible items as well.
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If you sell an asset after owning it for less than a year, you will be taxed like your ordinary income because it’s a short-term capital gain.
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Long-term capital gains are taxed at 0%, 15%, and 20%.
Short-term capital gains are taxed at ordinary income and do not benefit from special tax rates. Many people choose to hang onto their assets for a year or longer since they are taxed at a more favorable rate than salary and wages. However, some people choose to sell their assets if they need money right away.
If you choose to sell your asset when it’s still a short term, you are paying the tax for the bracket you fall under for your marginal income. In the United States, there are seven federal tax brackets, and the rates range from 10% to 37%.
The tax for long-term capital gains is almost always lower than if you acquired and sold the asset in less than a year. Holding onto assets for a year or more can give you a more favorable tax outcome.
Long-Term Capital Gains Tax Rates
There was a change to long-term capital gains after the Tax Cuts and Jobs Act (TCJA) was passed in 2018. Before the TCJA act was passed, the tax brackets for long-term capital gains were more closely aligned to the income tax brackets, making them taxed more like short-term capital gains.
Since the passing of the TCJA, there have been unique tax brackets for long-term capital gains tax. The numbers change from year to year.
Here are the numbers to keep in mind when it comes to long-term capital gain tax rates for the year 2022:
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0% rate: up to $41,675 for singles, up to $55,800 for head of household, up to $83,350 for married filing jointly, up to $41,675 for married filing separately
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15% rate: $41,676 to $459,750 for singles, $55,801 to $488,500 for head of household, $83,351 to $517,200 for married filing jointly, up to $41,675 to $258, 600 for married filing separately
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20% rate: over $459, 750 for singles, over $488, 500 for head of household, over $517, 200 for married filing jointly, over $258,600 for married filing jointly
Short-Term Capital Gains Tax Rates
As stated above, short-term capital gains are taxed just like ordinary income. Any income from investments held for less than a year has to be included in your taxable income for that year. So, if you have a $60,000 taxable income and $5,000 from short-term investments, your taxable income would increase to $65,000.
Your tax that you will pay on the short-term capital gains follows the tax bracket that you have for your ordinary income. Here are some outlines below so you will know what to expect for tax brackets.
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10%: Up to $10,275 for singles, up to $14,650 for head of household, up to $20,550 for married filing jointly, up to $10,275 for married filing separately
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12%: $10,276 to $89,075 for singles, $14,651 to $55,900 for head of household, $20,551 to $83,550 for married filing jointly, and $10,276 to $41,775 for married filing separately
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22%: $41,776 to $89,075 for singles, $55,901 to $89,050 for head of household, $83,551 to $178,150 for married filing jointly, and $41,776 to $89,075 for married filing
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24%: $89,076 to $170,050 for singles, $89,051 to $170,050 for head of household, $178,151 to $340,100 for married filing jointly, and $89,076 to $170,050 for married filing separately
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32%: $170,051 to $215,950 for singles, $170,051 to $215,950 for head of household, $340,101 for married filing jointly, $170,051 to $215,950 for married filing separately
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35%: $215,951 to $539,900 for singles, $215,951 to $539,900 for head of household, $431,901 to $647,850 for married filing jointly, $215,951 to $323,925 for married filing separately
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37%: Over $539,900 for singles, over $539,900 for head of household, over $647,850 for married filing jointly, over $323,925 for married filing separately
Keep in mind that ordinary income is taxed at graduated rates depending on your income. Short-term capital gains can be taxed at a higher rate than your income, though if the increase in income from the capital gains causes you to jump into a higher marginal tax bracket.
So, if you are filing as single and you are in the 22% tax bracket, your first $9,950 would be taxed at 10%, while the portion from $9,951 to $40,525 would be taxed at 12%, and the income from $40, 526 to $86,375 would be taxed at 22%.
Part of the capital gain you have of $10,000 would also be taxed at 22%, and some parts are taxed at the 24% tax bracket. This is because the United States tax system is progressive, and each income level can be taxed at a different rate.
Understanding capital gains taxes can be complicated, especially if it’s your first time dealing with the tax brackets and numbers. If you have difficulty understanding the brackets and are not sure how to file your taxes, it’s worth meeting with a financial advisor or accountant.
Filing your taxes correctly is important, and you want to make sure you do not risk getting audited or having another issue from filing your capital gains taxes incorrectly.
Advantages of Long-Term Capital Gains
Although it can be hard to hang onto assets when you want to sell them and make money, letting your capital gains become long-term assets has many advantages. The tax rate is almost always lower than if you only hold onto your asset for a year or less.
For example, let’s say you bought 100 shares of a stock at $20 per share, and then you were able to sell them at $50 per share. If you are earning $100,000 per year as income and you are filing as married filing jointly, here are some of the taxes you can expect to pay after a year versus shorter than a year:
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You would have a capital gain of $3,000 in the above scenario. For a long-term capital gain, you would be taxed at 15% for a tax of $450. This means your profit after tax is $450.
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For a short-term capital gain, you would be taxed at 22% for an overall tax of $660. This is a profit after tax of $2,340.
So, if you hang onto your asset for longer than a year and turn it into a long-term asset, you will pay $450 in taxes. If you sold the asset in less than a year, you would be taxed at the 22% rate since you are married, filing jointly, and making $100,000 a year.
This adds $210 to your capital gains tax, so you will have a total of $660 to pay. Some people choose to sell their assets and have short-term capital gains because they find that they have a higher return when they are cashing in the investments frequently over and over.
This allows them to move the funds into new investment opportunities rather than hanging onto one, which is what you would do for long-term capital gains.
The higher return does not always result in lower capital gains taxes, and you might find yourself with higher short-term capital gains, which make the return investment less valuable. This is why it’s always important to weigh the pros and cons before deciding to sell or hold onto an asset.
When you make too many changes to your investments and end up with high payments of capital gains taxes and commissions, you are taking place in what investors call churning.
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How To Minimize Capital Gains Tax
Now that you see how expensive capital gains taxes can be, you might be wondering if there are some ways you can minimize the taxes. Here are some suggestions to make the most of your assets and lessen taxes:
1. Hold onto the asset
Unless you need money right away from an asset sale, try to hold onto the asset for a year or longer. This will qualify you for a short-term capital gains rate and allow you to pay less overall taxes.
2. Exclude home sales
You can exclude your home if you have used it as your main residence for two years in the last five years. You also can’t use another home for the same two-year period. This allows you to exclude up to $250,000 if you’re single and $500,000 if you are married and filing jointly.
3. Carry losses over
If your net capital loss is more than what you can deduct in one year, the IRS allows you to carry the excess into the following year.
4. Rebalance with dividends
Instead of reinvesting in new dividends, you can rebalance the ones you have by putting the money into other underperforming investments. Many people choose to rebalance by selling securities that are doing well, and then they can put that money into other dividends that are underperforming.
This allows you to avoid selling investments that are doing well. Holding onto investments that are doing well means you have the potential to make more money in the future. It also allows you to avoid capital gains that could have come from the sale.
5. Consider a robo advisor
Robo advisors are becoming more and more popular because they can manage your investments for you automatically. This means less work for you, and the robo advisor can determine which financial strategies work the best for you.
6. Use tax-advantaged accounts
This includes things like 401(k) plans and individual retirement accounts. You can also use a 529 college savings account. These accounts allow you to have investments that are tax-deferred or, in some cases, even tax-free.
So, you don’t have to pay capital gains tax if you sell the asset that is in the account. You also don’t have to pay any taxes on investment earnings that are in IRA and 529 (college savings) accounts.
If you are eligible for any of these accounts, you might want to consider putting your investment in them to avoid overpaying in taxes next year when you are filing.
Summary
Capital gains tax can be confusing, especially when you are deciding on whether to keep or sell an asset. In general, you can usually pay less in taxes when you keep the asset for a year or longer, making it a long-term asset. Short-term assets are taxed like ordinary income, which means you could be taxed as high as 37%.
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