Capital Gains Tax Explained

Selling your capital assets may be an excellent strategy to make some extra money, but be careful that you are aware of the rules of capital gains taxes so you understand your responsibilities as a taxpayer.

Table of Contents

Key Takeaways:

  • Capital gains tax is an IRS tax that must be paid for the profit earned when a taxpayer sells a capital asset, such as property, stocks, or bonds, for a higher price than they initially paid.
  • The tax rate for short-term capital gains that were held for less than a year coincides with the ordinary tax bracket rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%, depending on the individual’s income and filing status.
  • The tax rates for long-term capital gains that were held for more than 12 months are 0%, 15%, and 20%, depending on the individual’s income and filing status.
  • There are exceptions to how capital gains are taxed for collectible capital assets, owner-occupied real estate, and investment real estate. 

What Is Capital Gains Tax?

Capital gains tax is an IRS tax that must be paid when a taxpayer sells a capital asset for more than they paid for it. When individuals make a profit through the sale of one of their capital assets, the IRS views this profit as taxable income, so it is important that they understand how capital gains taxes work.

What Is A Capital Asset?

A capital asset is a type of tangible property that is held by an individual or business. There are several types of property that are considered capital assets by the Internal Revenue Service, such as:

  • Real estate property
  • A home
  • A stock
  • A car
  • A bond
  • Art
  • Machinery
  • Land

What Are Capital Gains and Capital Losses?

Capital gains and losses describe the difference between what an individual paid for an asset and the amount that the asset was sold for. If the value of the asset grows during the time you hold the asset, the taxpayer will have a capital gain.

On the contrary, if a capital asset that an individual purchased depreciates in value during the time they held the asset, they will have a capital loss at the time they choose to sell.

Short-Term Vs. Long-Term Capital Gains

Capital gains are classified as short-term or long-term depending on how long the taxpayer held the asset after purchasing it before they sold the asset, and there is a different tax system for each of these types.

If the asset was sold for a profit during the first 12 months of owning the property, it is considered a short-term capital gain.

If the asset was sold for a profit after being held for a period longer than 12 months, it is considered a long-term capital gain.

Capital Gains Tax Rates

The tax rates for capital gains are dependent on several factors, such as the taxpayer’s income, filing status, and how long they hold onto the asset.

2023 Short-Term Capital Gains Tax Rates

Capital assets that are sold within 12 months of the original purchase date are taxed at the same tax rates as ordinary income tax brackets. The tax rates for short-term capital gains that correspond with ordinary income tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, and the taxable income bracket depends on the filing status of the taxpayer.

2023 Long-Term Capital Gains Tax Rates

In general, the capital gains tax rates for long-term capital assets that were held for more than a year are 0%, 15%, and 20%. In order to determine which tax rate they should use when calculating their capital gains taxes, individuals must consider their annual income as well as their tax filing status.

0% Tax Rate

Single Filing: $0 to $44,625

Head Of Household: $0 to $59,750

Married Filing Jointly: $0 to $89,250

Married Filing Separately: $0 to $44,625

15% Tax Rate

Single Filing: $44,626 to $492,300

Head Of Household: $59,751 to $523,050

Married Filing Jointly: $89,251 to $553,850

Married Filing Separately: $44,626 to $276,900

20% Tax Rate

Single Filing: $492,301 and above

Head Of Household: $523,051 and above

Married Filing Jointly: $553,851 and above

Married Filing Separately:$276,901 and above

Exceptions To Capital Gains Tax Rates

There are certain rules and exceptions related to capital gains tax that must be considered when figuring out capital gains tax liability.

Collectible Capital Assets

While the IRS classification for capital assets generally refers to valuable property that individuals can own, certain assets are considered especially valuable and must be taxed at a different tax rate. These valuable items are known as “collectibles.”

Some examples of collectible assets include:

  • Fine art
  • Precious metals
  • Antiques
  • Coins

Collectibles that are sold after being held for longer than 12 months that would normally be subject to long-term capital gain taxation are instead taxed at a maximum capital gains tax rate of 28%, no matter which tax bracket the taxpayer falls in. This means that taxpayers who belong to a lower tax bracket will have to pay a capital gains tax rate higher than the rate for their regular income taxes, and taxpayers who belong to a higher tax bracket will pay a capital gains tax rate lower than the rate for their regular income taxes. 

Owner-Occupied Real Estate

The capital gain on owner-occupied real estate is subject to different tax treatment than other types of capital assets. When a person sells their primary residence that they have lived in for two or more years, $250,000 of the capital gains on the sale of a home can be deducted from their taxable income, and married couples who file jointly can deduct $500,000. 

Another difference in taxation for owner-occupied real estate compared to other capital assets is that if the sale of personal property results in a capital loss, they will not be able to claim the tax deduction of this amount from their gains. 

For example, if a single taxpayer purchases a home for a sale price of $150,000 and sells the house 3 years later after living in it for $425,000, they will have earned a $275,000 profit on the sale. $250,000 of the capital gains can be deducted from their taxable income, but the remaining $25,000 must be reported and is subject to capital gains tax.

Investment Real Estate

Investment properties are also subject to unique tax rules compared to other capital assets. Real estate investors can usually claim depreciation deductions against their income as a way to reflect a property’s deterioration over time. 

By deducting this amount based on the home’s physical condition, this tax break effectively reduces how much they were considered to have initially paid for the property. This means that if the taxpayer earns a profit when selling the property, their capital gain will be higher due to the lowered initial purchase amount.

For example, if a single taxpayer purchases a property for $150,000 and can claim $5,000 in depreciation, their taxes will reflect that they paid $145,000 for the building. When the real estate is sold, the $5,000 that was deducted is treated as recapturing the depreciation deductions. If the house is later sold for $175,000, the capital gains would be $30,000. The $5,000, which is the recaptured amount, would be taxed at the recaptured amount tax rate of 25%, and the remaining $25,000 would be taxed at the long-term capital gains tax rate corresponding with their income.

Other Investment Exceptions

High-income earners may also be subject to the net investment income tax, an IRS tax that imposes an additional 3.8% tax rate on their investment income, such as capital gains. People will be subject to the net investment income tax if their modified adjusted gross income (MAGI) exceeds $200,000 if single or a head of household, $250,000 if married and filing jointly, or $125,000 if married and filing separately.

How To Calculate Capital Gains Tax

1. Figure Out Cost Basis

Determining the cost basis of an asset is the first step when calculating capital gains. Taxpayers can figure this amount by adding the purchase price to any fees or commissions they paid. Additionally, reinvested dividends on stocks as well as other factors may increase the basis.

2. Identify Realized Amount

The second step to calculating capital gains tax is for the taxpayer to determine the realized amount. The realized amount is calculated by subtracting any commissions or fees from the price the asset was sold for.

3. Subtract Cost Basis

The third step for taxpayers to calculate the capital gains tax is to determine the difference between the basis and the realized amount. This calculation is made by subtracting the cost basis, or the amount they purchased the asset for, from the realized amount, which is the amount they sold the asset for. 

The taxpayer has a capital gain if they sell their capital assets for more than what they initially paid for them. On the other hand, the taxpayer has a capital loss if they sell their capital assets for an amount that is less than what they initially paid.

4. Refer To The Capital Gains Rate Chart

Now that the taxpayer has determined the amount of their short-term and long-term capital gains, they can figure out which tax rate applies to their situation by referring to the different capital gains tax rates.

Tips For Reducing Capital Gains Tax

While the taxes that must be paid on investment profits may deter people from seeking out investment opportunities, it is beneficial to learn that there are several strategies that are completely legal that taxpayers can employ to minimize their capital gains tax liability.

  • Hold onto investments for more than 12 months.
  • Maximize capital loss deductions.
  • Maintain a record of qualifying expenses related to making or maintaining an investment.
  • Consider tax-advantaged accounts with tax-free or tax-deferred distributions. 
  • Understand tax exclusion requirements.

Calculating and paying capital gains taxes to the government is one of your responsibilities as an investor, but with the help of tax experts, you have nothing to worry about. If you have any questions about the process of filing your tax return, calculating your tax liability, or paying taxes in general, the professionals at Ideal Tax are here to help. Set up a free tax consultation today to learn how you can make the most of any tax shelter, tax haven, tax credit, or other tax avoidance strategy that can help you save money this tax season.

Frequently Asked Questions

Will I owe capital gains taxes on capital assets I haven’t sold yet?

No, you will only have to pay capital gains taxes after selling the capital asset for more than what they initially paid, even if the asset has appreciated in value since purchasing. Capital assets that are being held are considered “unrealized,” so until they are “realized” when they are sold for profit, you will not have to pay any capital gains tax.

When are capital gains taxes due?

Taxpayers must pay capital gains taxes when they file their tax return for the year in which they realized the gain. So, if they realized a capital gain in 2022, they must report and pay taxes on the capital gain when they file their 2022 tax return in April of 2023.

Author: Luis Ceja - Director of Operations
Author: Luis Ceja - Director of Operations

Luis serves as the Director of Operations for Ideal Tax, overseeing a multifaceted team including case management, tax professionals, document specialists, customer support, training, and development.

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