Did you recently sell your house? Have you made money in the stock market? Are you accruing interest in your savings account?
If so, you may owe capital gains taxes. The capital gains tax is a percentage of earnings that you pay to the federal government. And, it’s required for anyone who’s making money off of their assets.
The terms and conditions surround the capital gains tax can be confusing, but we’re here to break everything down. Just keep reading to learn more.
What Is Capital Gains Tax?
A capital gains tax is a required payment to the government. It taxes the financial growth that investors get from selling their investments.
It’s important to note that these taxes only apply to realized capital gains. This means that you only owe money on the sale of the assets once the sale is final. So, you do not have to pay capital gains taxes on the property even if you own the property at the end of the year.
This applies to stocks, too. No matter how long you hold your stocks, you will not owe any taxes on the appreciation until you sell them.
Short-Term vs Long-Term Capital Gains
The capital gains tax in the United States only applies to profits that you make on assets that you hold for more than a year. Those profits that you make after holding onto an asset for more than a year are long-term capital gains.
On the other hand, there are short-term capital gains. These are the profits that you make on assets that you own for less than a year.
Depending on your tax bracket, your long-term capital gains will be worth a 0%, 15%, or 20% tax on the profits. Your short-term capital gains will have the same taxation as your regular income.
Capital losses are the amount of money that you lose by investing in these kinds of things. The good thing about your losses is that they can offset your gains.
So, your amount of taxable gains lowers. Thus, you’ll pay less in taxes.
The amount of your long-term capital gains minus your capital losses is your net capital gain. This is the total number of your capital gains that are taxable.
Since your capital losses offset your capital gains, it’s not necessarily a bad thing to have capital losses. It may sound like you’re losing money, but – as long as your net capital gain is positive – you’ve made money.
What Is the Capital Gains Tax Rate for 2021?
As we said, short-term capital gains and long-term capital gains get taxed separately. Your short-term capital gains become a part of your regular income, while your long-term capital gains follow the regular capital gains tax.
Taxation on Short-Term Capital Gains
All of this means that your short-term capital gains have the same tax rate as your ordinary income. However, if your short-term capital gains push you into a higher tax bracket, you will have the higher tax rate associated with that higher tax bracket.
In other words, the total of your ordinary income and your short-term capital gains follow the regular tax brackets and tax rates. This could mean that you have the same tax rate or a higher tax rate, depending on which bracket you end up in.
The same rules apply to any dividends that your assets pay. These aren’t technically capital gains, but they do represent a part of the profit that you can make from these kinds of investments.
In the United States, these dividends have taxation at the rate of ordinary income. However, only those who belong to the 15% tax bracket or higher pay taxes on their dividends.
Taxation on Long-Term Capital Gains
Since long-term capital gains have a different taxation rate, there is another set of rates to consider.
If you’re filing single, these are the rates that you should follow:
- 0% on capital gains up to $40,400
- 15% on capital gains from $40,401 to $445,850
- 20% on capital gains over $445,850
If you’re filing as the head of household, follow these rates:
- 0% on capital gains up to $54,100
- 15% on capital gains from $54,101 to $473,750
- 20% on capital gains over $473,750
If you’re filing jointly as a married couple or a surviving spouse, you should follow these rates:
- 0% on capital gains up to $80,800
- 15% on capital gains from $80,801 to $501,600
- 20% on capital gains over $501,600
If you’re filing separately as a married couple, follow these rates:
- 0% on capital gains up to $40,400
- 15% on capital gains from $40,401 to $250,800
- 20% on capital gains over $250,800
All of these tax rates are consistent with the fact that capital gains are taxed at a lower rate than individual income.
Are There Any Exceptions to the Capital Gains Tax?
There are a few exceptions when it comes to the capital gains tax rate of some investments, like the following:
- Owner-Occupied real estate
- Investment real estate
- Investment exceptions
Each one of these categories has its own rules for taxation.
Collectibles include items like art, jewelry, antiques, precious metals, stamp collections, and similar items. These kinds of things have a taxation rate of 28%, no matter what your income is.
So, even if you’re in a lower tax bracket, you still have to pay a 28% tax. And, those who are in a higher tax bracket won’t have to pay more than 28%.
Owner-Occupied Real Estate
Real estate capital gains are different if you’re selling the residence that you’re primarily living in.
If you’re filing independently, $250,000 of the capital gains on the property that you’re selling are excluded from the taxation. This means that you should take the amount that you made on the property and subtract it by $250,000, the remaining amount is the amount that becomes taxed.
If you’re filing jointly, $500,000 of the capital gains on the property that you’re selling are excluded from taxation. Similar to the independent example, you should subtract your total capital gains on the sale of the property by $500,000. The remaining amount is the amount that’s taxed.
These rules apply as long as the seller has lived in the property for two years or more.
The downside to this rule is that any capital losses are not deductible. So, if subtracting the capital gains by the offset is negative, there are no deductions.
In most cases, you can count significant repairs and upgrades to the total value of your home. Since this increases the value of the home, this decreases the amount of capital gains tax that you have to pay.
Investment Real Estate
Investors who own real estate can take depreciation deductions against their capital gains. This amount reflects any deterioration over time of the properties that they own. Keep in mind that the deterioration of the home’s condition is completely separate from the appreciation of the property that is tied to the real estate market.
The deduction that real estate investors get increases the amount of capital gains tax that they have to pay. This is because it increases the gap between the property’s value after deductions and its sale price.
There is another type of tax to consider: the net investment income tax. This applies if your investment income is relatively high.
The net investment income tax imposes an extra 3% of taxation on your net investment income. This includes the number of capital gains that you have if your modified adjusted gross income is above a certain amount. Keep in mind that your modified adjusted gross income is different than your taxable income.
These are the thresholds for the modified adjusted gross income:
- $250,000 if you’re filing jointly as a married couple or as a surviving spouse
- $200,000 if you’re filing as single or head of household
- $125,000 if you’re filing separately as a married couple
If you’re a real estate investor who is nearing retirement, you should plan out your profits very carefully. You want to make sure that you’re not selling all of your assets at once to ensure that you’re not raising your capital gains tax unnecessarily.
Will the Capital Gains Tax Change?
As Suzanne Clark reports, President Biden is proposing to raise the capital gains tax. However, this is only going to affect those who are earning more than one million dollars in long-term capital gains. He is proposing to raise this taxation rate to 39.6%.
This tax adds to the existing 3.8% investment surtax that the government places on high-income investors. This means that the total tax rate could be 43.4%, not counting state taxes.
Where Can I Learn More About Capital Gains Tax?
Understanding the capital gains tax is essential for anyone who is planning on pursuing or actively pursuing investing. It’s important to plan out your capital gains and capital losses to ensure that you’re getting the best taxation rate possible each year.
To do this, you should work with an accountant to get your best options.
While you’re navigating the world of capital gains, you should be sure to check in with our blog frequently. We share tons of information about capital gains tax and other important financial terms.
Be sure to check out our blog for all of the information that you need.