When an asset is sold for a profit, Uncle Sam wants his share. Depending on your income level, your capital gains rate might be lower than your ordinary tax rate.
Delving into the labyrinth of capital gains taxation unveils a complex web of financial intricacies that every investor must navigate. When investments appreciate and are sold, they become subject to taxation, with the treatment of these gains varying based on factors like how long you owned the investment and how much taxable income you have that year. Understanding the intricacies of how capital gains are taxed is essential for anyone looking to minimize taxes, while staying compliant with the IRS rules.
Let’s look at a few key questions to about the taxation of capital gains.
Any time you sell an investment for more than you bought it, you potentially create a taxable capital gain. Capital gains can apply to almost any investment that is sold at a profit, such as stocks, bonds, real estate, precious metals, options contracts, or even cryptocurrency.
When you sell an investment at a profit, the difference between the selling price and the purchase price (a.k.a cost basis) is considered a capital gain. Fortunately, you can potentially reduce the gain you realize a bit by including certain expenses like the costs incurred to sell the asset.
Learn more about calculating your capital gains taxes: Save on Taxes: Know Your Cost Basis.
No, there are many times when selling an asset does not result in a taxable gain. Capital gains taxes generally only apply to assets held in a taxable account like a bank or brokerage account. Assets held in tax-advantaged accounts, such as an IRA or 401(k), avoid capital gains taxes on the sale of an asset.
At the federal level, capital gains are taxed based on the several factors including the type of asset, how long you held the asset, and your overall income level.
If you only held the investment for a year or less, then the short-term capital gains tax rates will apply. These tax rates and brackets are the same as those applied to ordinary income, like your wages, and currently range from 10% to 37% depending on your income level.
2024 short-term capital gains tax rates and brackets Tax rate Tax rate Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Tax rate Taxable income bracket Single filer Taxable income bracket Married filing jointly Taxable income bracket Married filing separately Taxable income bracket Filing head of household Tax rate 0% Taxable income bracket Standard or itemized deduction amount Taxable income bracket Standard or itemized deduction amount Taxable income bracket Standard or itemized deduction amount Taxable income bracket Standard or itemized deduction amount Tax rate 10% Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Tax rate 12% Taxable income bracket $11,601 – $47,150 Taxable income bracket $23,201 – $94,300 Taxable income bracket $11,601 – $47,150 Taxable income bracket $16,551 – $63,100 Tax rate 22% Taxable income bracket $47,151 – $100,525 Taxable income bracket $94,301 – $201,050 Taxable income bracket $47,151 – $100,525 Taxable income bracket $63,101 – $100,500 Tax rate 24% Taxable income bracket $100,526 – $191,950 Taxable income bracket $201,051 – $383,900 Taxable income bracket $100,526 – $191,950 Taxable income bracket $100,501 – $191,950 Tax rate 32% Taxable income bracket $191,951 – $243,725 Taxable income bracket $383,901 – $487,450 Taxable income bracket $191,951 – $243,725 Taxable income bracket $191,951 – $243,700 Tax rate 35% Taxable income bracket $243,726 – $609,350 Taxable income bracket $487,451 – $731,200 Taxable income bracket $243,726 – $365,600 Taxable income bracket $243,701 – $609,350 Tax rate 37% Taxable income bracket $609,351 or more Taxable income bracket $731,201 or more Taxable income bracket $365,601 or more Taxable income bracket $609,350 or moreOn the other hand, if you held the investments longer than a year, long-term capital gains tax rates will apply and any gains are subject to lower preferential tax rates, ranging from 0% to 20% depending on your income level.
2024 long-term capital gains tax rates and brackets Tax rate Tax rate Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Tax rate Taxable income bracket Single filer Taxable income bracket Married filing jointly Taxable income bracket Married filing separately Taxable income bracket Filing head of household Tax rate 0% Taxable income bracket Taxable income bracket Taxable income bracket Taxable income bracket Tax rate 15% Taxable income bracket $47,026 – $518,900 Taxable income bracket $94,051 – $583,750 Taxable income bracket $47,026 – $291,850 Taxable income bracket $63,001 – $551,350 Tax rate 20% Taxable income bracket $518,901 or more Taxable income bracket $583,750 or more Taxable income bracket $291,850 or more Taxable income bracket $551,350 or moreAdditionally, high-income earners may also be subject to the net investment income tax (NIIT), which adds an extra 3.8% tax on investment income, including capital gains, for individuals with modified adjusted gross income (AGI) above certain thresholds.
Net investment income tax (NIIT) Tax rate Tax rate Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Tax rate Additional 3.8% tax if income is above the limits below Single filer Additional 3.8% tax if income is above the limits below Married filing jointly Additional 3.8% tax if income is above the limits below Married filing separately Additional 3.8% tax if income is above the limits below Filing head of household Tax rate AGI limits Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits below Additional 3.8% tax if income is above the limits belowAnd remember, state taxes could also apply. Each state has its own rules about how the gains are taxed, and some states don’t tax these gains at all.
There are many other asset classes out there with their own unique tax rules. For instance, futures contracts, options on futures, options on broad-based indexes, and collectables (which includes metals like gold) are subject to a special tax treatment.
Derivative contracts like futures contracts, options on futures, or options on broad-based indexes, are subject to Internal Revenue Code section 1256 (a.k.a 1256 contracts). These types of assets get special tax treatment called the 60/40 rule, where 60% of gains are taxed at the lower long-term capital gains rate and 40% at the ordinary income tax rate. In addition, if you hold section 1256 contracts, they're subject to the mark-to-market rule. If you hold these assets through the end of a calendar year, you'll have to recognize an unrealized gain or loss based on the fair market value on December 31.
Gains from the sale of collectibles, such as art, antiques, coins, and precious metals, are subject to a higher long-term capital gains tax rate of 28%. Whereas shorter-term gains on collectables are taxed at the ordinary income tax rates.
Cryptocurrencies are taxed a bit different than most people expect. While cryptocurrencies, like bitcoin, are often thought of as digital currencies, the IRS disagrees. The IRS does not consider them to be a currency; in the IRS’s eyes, they are "property," which means cryptocurrencies are subject to the same long- and short-term capital gains tax rates as other investments.
When you sell or trade cryptocurrencies for another asset (or even for a different cryptocurrency), you create a taxable event, and any gain realized needs to be reported on your tax return. Even if you don’t get a Form 1099 for a cryptocurrency transaction, it still needs to be reported on your tax return. Also be aware that using cryptocurrency to buy goods or services is also a taxable event because you exchanged the cryptocurrency for something.
No one likes losing money, but sometimes, losses are unavoidable. If you sell an investment for less than you paid for it, a capital loss has been realized. Fortunately, investment losses have a silver lining; you can use capital losses to offset other capital gains, reducing your overall tax bill. If total capital losses exceed your capital gains, you can deduct up to $3,000 of the excess losses against other types of income, such as wages. Any remaining losses beyond the $3,000 deduction can be carried forward to offset future income.
The tax benefits from capital losses are often good enough that many tax savvy investors regularly look for losses in their portfolios so they can use them to reduce their taxes in a process known as tax-loss harvesting. But you do have to be careful when strategically realizing losses to avoid the wash sale rule, which could reduce or remove the potential tax benefits of loss harvesting.
It's always possible. In the end, Congress writes the tax laws, so it always has the option to change the tax rates and brackets. For example, back in the late 1970s, the maximum long-term capital gains rate rose to near 40% for some investors with the biggest gains. That’s why meeting with your tax and financial advisor at least once a year is important because they’re tracking those changes and can help update your wealth management plan accordingly.
Navigating the complexities of capital gains taxes is crucial for investors seeking to optimize their overall wealth management strategy. Understanding the various tax rates, holding periods, and special rules for different asset classes can significantly impact your tax liabilities and investment decisions. Given the intricacies involved, it's prudent to seek professional guidance from a tax professional and/or a financial planner to get personalized advice tailored to your specific circumstances.
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