Capital Gains Tax Rate – An Exhaustive Guide
While most of us make money by going in every day to a job, and taking home a regular paycheck – there are numerous other ways to make a living. One of the most profitable, is through something called capital gains.
These are profits from selling assets – this could be a business, stock, or real estate. Since you’re making money from the sale of any of these items – this is considered taxable income.
However, somewhat confusingly, the rate at which you are taxed on these items varies. If you have held an asset for less than a year, the income tax rate will usually fall within ordinary income tax brackets.
Longer held assets are taxed differently. Essentially, the two versions of the capital gains tax rate are long-term and short-term.
What Is The Short-Term Capital Gains Tax?
If you have an asset for a year or less and you sell it – this would be considered a short-term sale. This means it would fall under the jurisdiction of a short-term capital gains tax.
These rates correspond to your normal income tax bracket. This is mostly because you are less likely to make a large amount of money from the sale of an asset held for a short length of time.
What Is The Long-Term Capital Gains Tax?
If you hold an asset for a long period of time (generally 12 months or longer) – you will pay a different rate of tax on the sale of that asset. These rates are generally also lower – rewarding you for holding an asset and watching the value grow.
Normally the long-term capital gains tax rate is 20%, 15%, or 0%. If you invested in a company from its founding and sold it after 10 years – or you bought a house and sold it 20 years later – you would have to pay the long-term capital gains tax.
How Are Capital Gains Calculated?
Simply, if you earn a profit from any item that you own (including items like stocks), that would be classified as a capital gain. If you lose money on one of these assets, that would be classified as a capital loss.
Capital gains taxes can come from real estate, bonds, boats, cars, stocks, and other investments. Capital gains tax calculators can be used to estimate how much you might owe Uncle Sam, after you sell a big asset.
Like federal income taxes, capital gains taxes are progressive. The more you make from assets, the more you have to pay in income tax.
If you lose more money than you gain from capital assets, you can actually deduct the amount on your tax return. If you gain money, this would be referred to as a net capital gain.
Those who are married filing separately can typically claim more deductions when it comes to the capital gains tax. Capital losses can also help offset any taxes on capital gains, as they lower your overall tax liability.
There is one caveat to making money from assets – if the asset is deemed a “collectible” – you may be taxed at 28%. This includes assets like coins, antiques, artwork, and even precious metals.
If you own one of these for a long period of time – you will profit in the form of long-term capital gains. But the tax rate will usually be 28% – unlike other assets.
Net Investment Income Tax (And Head Of Household Exceptions)
There is another exception to normal capital gains tax rates, and it is called the net investment income tax. If you start to make a large amount of money (over $200,000 if you’re the head of household) – you will have to pay an additional 3.8% in taxes.
This small (but significant) rule is one of the many reasons why we recommend you utilize a qualified tax professional. Your gross income being higher actually means you have to look for more ways to pay less taxes – and your net investment income being high is one red flag that also may make you more likely to be audited.
How To Minimize Capital Gains Taxes
There are a few different ways to minimize capital gains taxes. Most are simple, but we still recommend utilizing a qualified tax professional (or CPA) to make sure you are paying the least amount of tax possible.
Keep An Asset For Longer
In almost every case, keeping an asset for longer than a year will always work to your advantage. This will usually qualify you for the long-term capital gains tax, which is almost always lower.
The capital gains tax on long-held assets can be as low as 0%. While in some cases it may not be possible to hold an asset for this long, if you can, we highly recommend it.
Use Tax-Advantaged Accounts
There are numerous accounts that will not accrue taxes – we highly recommend using one of these, whenever possible. 401(k) plans, 529 college savings accounts, and IRAs (individual retirement accounts) will usually allow investments to get bigger – all while being tax-free (or at least almost tax-free).
This is a huge (legal) loophole, since you can avoid the capital gains tax by selling investments that are held within these accounts. Of these, 529 accounts and Roth IRAs do not require any taxes to be paid on gains.
Don’t Include Home Sales
If you are interested in making money from real estate, you can actually avoid paying taxes by selling your home. However, certain parameters must be met.
For starters, you have to have used it as your main resident for two of the previous five years. Next, you must have owned it during this time period, and you also must not have excluded another home from capital gains for the two years prior.
Once those terms are met, you can actually not pay taxes on up to a $250,000 profit of the sale of your home (or $500,000 if you’re married). Done properly, you can make a lot of money with this method, over decades.
Carry Your Losses Over
If you lose a lot of money in one year, and actually exceed what you can deduct for a 12 month period – you can actually carry it over into the next fiscal year. The IRS lets the capital loss roll over, and if you like to gamble with your money, this exception can help you save a large amount of money.
Let A Robot Help
Interestingly, AI financial advisors can be hugely profitable for the average taxpayer. They use strategies like tax-loss harvesting, and generally help you avoid major losses before they happen.
Normally, if you have failing investments, you’d sell the winners and then put this money into the less stellar investments. However, using this method, you’d have to pay a capital gains tax.
If you instead use dividends, not only do you avoid the capital gains tax – you keep your winning investments. This is almost always the best strategy to utilize – especially if you often gamble with risky investments.
Other Factors To Consider
If you make money via capital gains, it is treated a little bit differently than ordinary income. Taxpayers everywhere still have to pay the IRS income tax from capital gains, but these types of gains come with caveats that are distinct from regular income.
Usually capital gains fall into the bracket of high-income, though there are no real tax cuts for any type of capital gains. If the income you make falls into the qualifying category of capital gains in any tax year, you will have to give Uncle Sam his cut.
If you are looking to invest earnings made via capital gains, a mutual fund is a safe option. Another choice is to look for assets that have good amounts of appreciation possible (collecting items is one avenue) – and not assets that show lots of depreciation (like cars).
To lessen your federal income taxes (no matter who you are) – you can look for tax deductions. However, capital gains cannot really be claimed as deductible.
Another way to accumulate wealth over time – is to acquire a capital asset. A capital asset is an item like a car or home.
These items usually end up being worth more than the purchase price – which usually makes them a very safe long-term investment. Married couples often share in the cost of these assets (like buying a home together) – which also lets them reap the rewards and profits jointly.
The Bottom Line On The Capital Gains Tax Rate
You always have to pay taxes – there’s simply no (legal) way around it. While capital gains are treated differently than ordinary income, you’ll still need to give up some of these gains to Uncle Sam.
We recommend hiring a qualified accountant or other tax professional, as they will best be able to find any ways (like an exemption) to lower your overall taxable income. They will also be able to look for other legal ways to lower your payment to the IRS, like avoiding a surtax that may come with higher income.
- “2020 Capital Gains Tax Calculator – See What You’ll Owe.” SmartAsset, smartasset.com/investing/capital-gains-tax-calculator.
- Amadeo, Kimberly. “Investment Income Is Taxed Lower Than Wages.” The Balance, 29 Nov. 2020, www.thebalance.com/what-is-the-capital-gains-tax-3305824.
- Ashford, Kate. “What Is the Capital Gains Tax Rate?” Forbes, Forbes Magazine, 11 Dec. 2020, www.forbes.com/advisor/investing/capital-gains-tax/.
- Michael Kitces, et al. “The Tax Impact Of The Long-Term Capital Gains Bump Zone.” Nerd’s Eye View | Kitces.com, 28 Feb. 2019, www.kitces.com/blog/long-term-capital-gains-bump-zone-higher-marginal-tax-rate-phase-in-0-rate/.
- Berry-Johnson, Janet. “Capital Gains Are the Profits You Make from Selling Your Investments, and They Can Be Taxed at Lower Rates.” Business Insider, Business Insider, 1 Dec. 2020, www.businessinsider.com/what-are-capital-gains.
- Boyte-White, Claire. “Long-Term vs. Short-Term Capital Gains Rates-Which Is More Favorable?” Investopedia, Investopedia, 22 Sept. 2020, www.investopedia.com/articles/personal-finance/101515/comparing-longterm-vs-shortterm-capital-gain-tax-rates.asp.
- Bromels, John. “Selling Stock: Are There Tax Penalties on Capital Gains?” The Motley Fool, The Motley Fool, 10 July 2020, www.fool.com/investing/how-to-invest/stocks/selling-stock-taxes/.
- “The Capital Gains Rate – Historical Perspectives on ‘Retroactive’ Changes.” The National Law Review, www.natlawreview.com/article/capital-gains-rate-historical-perspectives-retroactive-changes.
- “Capital Gains Tax Q&A.” Office of Financial Management, ofm.wa.gov/budget/state-budgets/gov-inslees-proposed-2019-21-budgets/proposed-2019-21-budget-and-policy-highlights/revenue-changes/capital-gains-tax-qa.
- “Capital Gains Tax.” Ballotpedia, ballotpedia.org/Capital_gains_tax.
- “Capital Gains Tax: What Is It, And What Are The Rates On Home Sales?” Capital Gains Tax (On Real Estate & Home Sales) | Rocket Mortgage, www.rocketmortgage.com/learn/capital-gains-home-sale.
- “Capital Gains Taxes, Losses.” Efile.com – It’s Less Taxing, www.efile.com/capital-gains-tax-rates-investment-income-loss-deduction/.
- “Capital Gains Taxes.” Capital Gains Tax (CGT) Rates, taxsummaries.pwc.com/quick-charts/capital-gains-tax-cgt-rates.
- “Capital Gains Taxes.” Seventy2 Capital, www.seventy2capital.com/learning_center/calculators/capital_gains_taxes.
- Credit: Ken Teegardin / CC BY-SA 2.0. “Capital Gains Taxes.” American Farm Bureau Federation – The Voice of Agriculture, www.fb.org/issues/tax-reform/capital-gains-taxes-and-stepped-up-basis/.
- Enda, Grace, and William G. Gale. “What Are Capital Gains Taxes and How Could They Be Reformed?” Brookings, Brookings, 27 Oct. 2020, www.brookings.edu/policy2020/votervital/what-are-capital-gains-taxes-and-how-could-they-be-reformed/.
- Fernando, Jason. “What Are Capital Gains Taxes?” Investopedia, Investopedia, 10 Dec. 2020, www.investopedia.com/terms/c/capital_gains_tax.asp.
- “Financial Learning Center.” Rocket HQ, www.rockethq.com/learn/personal-finances/capital-gains-tax.
- Fundrise.com, fundrise.com/education/glossary/capital-gains-taxes.
- Gobler, Erin. “Capital Gains Tax Guide for Investors.” The Balance, www.thebalance.com/capital-gains-tax-guide-for-investors-357401.
- Hanlon, Galen Hendricks and Seth. “Capital Gains Tax Preference Should Be Ended, Not Expanded.” Center for American Progress, www.americanprogress.org/issues/economy/reports/2020/09/28/490816/capital-gains-tax-preference-ended-not-expanded/.
- Heidenry, Margaret. “How Much Is Capital Gains Tax on Real Estate? Plus: How to Avoid It>.” Real Estate News and Advice | Realtor.com®, Realtor.com, 2 Mar. 2020, www.realtor.com/advice/finance/avoiding-capital-gains-taxes-real-estate/.
- “How Are Capital Gains Taxed?” Tax Policy Center, www.taxpolicycenter.org/briefing-book/how-are-capital-gains-taxed.
- “How Capital Gains Are Taxed.” How Capital Gains Are Taxed | SecurityBenefit.com, www.securitybenefit.com/tax-center/article/how-capital-gains-are-taxed.
- “How Does the Capital Gains Tax Work Now, and What Are Some Proposed Reforms?” Peter G. Peterson Foundation, www.pgpf.org/blog/2020/02/How-Does-the-Capital-Gains-Tax-Work-Now-and-What-Are-Some-Proposed-Reforms.
- “How to Calculate Capital Gains Tax.” H&R Block, 4 Dec. 2020, www.hrblock.com/tax-center/income/investments/how-to-figure-capital-gains-tax/.
- Kielar, Hanna. “Avoiding Capital Gains Tax on Real Estate.” Avoiding Capital Gains Tax on Real Estate | Quicken Loans, Quicken Loans, 25 Nov. 2020, www.quickenloans.com/learn/capital-gains-tax-on-real-estate.
- Mary Randolph, J.D. “Capital Gains Tax on Inherited Assets.” Www.alllaw.com, Nolo, 22 Oct. 2020, www.alllaw.com/articles/nolo/wills-trusts/capital-gains-tax-inherited-assets.html.
- Mengle, Rocky. “The 2021 Capital Gains Tax Rate Thresholds Are Out – What Rate Will You Pay?” Kiplinger, Kiplinger, 27 Oct. 2020, www.kiplinger.com/taxes/capital-gains-tax/601636/2021-capital-gains-tax-rate-thresholds.
- Miller, Terin. “What Is the Capital Gains Tax on Real Estate?” TheStreet, TheStreet, 7 Feb. 2020, www.thestreet.com/personal-finance/taxes/capital-gains-tax-on-real-estate-14911957.
- Moore, Stephen, et al. “Capital Gains Taxes.” Econlib, www.econlib.org/library/Enc/CapitalGainsTaxes.html.
- Murray, Jean. “How to Handle Capital Gains Taxes in a Business Sale.” The Balance Small Business, www.thebalancesmb.com/how-are-capital-gains-handled-in-the-sale-of-a-business-397789.
- Orem, Tina. “2020-21 Capital Gains Tax Rates and Calculator.” NerdWallet, 16 Nov. 2020, www.nerdwallet.com/article/taxes/capital-gains-tax-rates.
- Ramsey Solutions. “What Is the Capital Gains Tax?” Daveramsey.com, Ramsey Solutions, 18 Mar. 2020, www.daveramsey.com/blog/what-is-capital-gains-tax.
- “Realized Capital Gains.” Vanguard, investor.vanguard.com/investing/taxes/realized-capital-gains.
- Realized. “Capital Gain Tax Rates by State.” 2019 & 2020, www.realized1031.com/capital-gains-tax-rate.
- Robert Farrington. “Capital Gains Tax Brackets 2021: What They Are and Rates.” The College Investor, 26 Oct. 2020, thecollegeinvestor.com/23577/capital-gains-tax-brackets/.
- Royal, James. “2020-2021 Long-Term Capital Gains Tax Rates.” Bankrate, www.bankrate.com/investing/long-term-capital-gains-tax/.
- Schwab.com. “Investment Income Taxes.” Schwab Brokerage, www.schwab.com/taxes/investment-related-taxes.
- “Short Term / Long Term Capital Gains Tax Calculator.” TaxAct Blog, 25 Nov. 2020, blog.taxact.com/capital-gains-tax-calculator/.
- “State Taxes on Capital Gains.” Center on Budget and Policy Priorities, 12 Dec. 2018, www.cbpp.org/research/state-budget-and-tax/state-taxes-on-capital-gains.
- Stephen Fishman, J.D. “Avoiding Capital Gains Tax When Selling Your Home: Read the Fine Print.” Www.nolo.com, Nolo, 27 Aug. 2019, www.nolo.com/legal-encyclopedia/avoid-capital-gains-tax-selling-home-29901.html.
- “The Tax Break-Down: Preferential Rates on Capital Gains.” Committee for a Responsible Federal Budget, 25 Apr. 2018, www.crfb.org/blogs/tax-break-down-preferential-rates-capital-gains.
- “The Tax Elasticity of Capital Gains and Revenue-Maximizing Rates | Princeton University – Department of Economics.” Princeton University, The Trustees of Princeton University, economics.princeton.edu/working-papers/the-tax-elasticity-of-capital-gains-and-revenue-maximizing-rates/.
- “Tax-Loss Harvesting: Capital Gains and Lower Taxes.” Fidelity, 1 Dec. 2020, www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting.
- “TAX125 – GUIDE: Capital Gains Tax.” Weller Group LLC, wellergroupllc.com/taxes-resources/tax125-guide-capital-gains-tax.
- “Topic No. 409 Capital Gains and Losses.” Internal Revenue Service, www.irs.gov/taxtopics/tc409.
- TurboTax – Taxes, Income Tax. “5 Things You Should Know about Capital Gains Tax.” TurboTax Tax Tips & Videos, turbotax.intuit.com/tax-tips/investments-and-taxes/5-things-you-should-know-about-capital-gains-tax/L0m06D9lI.
- Wastler, Allen. “3 Ways to Manage Capital Gains Tax Bites.” MassMutual, blog.massmutual.com/post/capital-gains-manage.
- “What Is a Capital Gains Tax?” Tax Foundation, Tax Foundation, taxfoundation.org/tax-basics/capital-gains-tax/.