Traditional investments, like stocks, are the most common investments subject to to capital gains tax. But other investments and property that acquire value over time are also subject to capital gains. Capital gain taxes are calculated by subtracting the cost of the investment plus adjustments from the final selling price of said investment. This final amount is reported as capital gains. The final amount can be taxed at different rates depending on the investment type, holding period and total monetary gain.
Below we review how capital gains taxes are determined and what methods you can use to reduce them.
Capital Gains Tax Rates
The total tax amount will depend on a variety of factors, though the IRS taxes most individuals at a rate of zero to 15 percent.
Here are a few factors that determine capital gains tax rates:1
- A total income of less than $78,750 is set at zero percent
- A rate of 15 percent is set if your income is between $78,750 and $434,550, but this range will vary depending on your marriage filing status.
- Rates higher than 20 percent result from certain investment types and income amounts in excess of the 15 percent range.
Make sure to check with the IRS to understand how different investments are taxed.
Duration of the Investment
The amount of time you hold an investment can affect the amount of taxes you ultimately pay. The IRS has established two investment types: short-term and long-term.1 Investment duration is calculated from the day of purchase to the day of sale - over a year is considered long-term, while short-term is under a year.1
What Isn’t Affected by Capital Gains?
Certain types of property and accounts are not subjected to capital gains taxes. If applicable, see if you can utilize these property and account types to maximize your investment.
There are two general property types unaffected by capital gains. The first is business property, including products. The second is anything you create as an individual. This could be a book you wrote or an invention you patent.
Alternatively, specific retirement and education accounts are exempt and are not subject to capital gains taxes, such as a Roth IRA and a 529 plan.
Offsetting Capital Gains
Investments may not always pay off. Sometimes a market change results in your property reducing in value. This reduction (loss) is also factored on your taxes and is calculated into your capital gains taxes. This can lower your taxable income.
For example, if you receive $90,000 from selling one investment, you would be taxed in the 15 percent range. However, if you lost $15,000 on another investment, this would drop your total income from investments to $75,000, which could place you beneath the 15 percent tax range. These reductions and gains can only be combined if they are the same type of investment, long-term or short-term and are sold in the same year.1 Any excess loss above gains up to $3,000 can offset ordinary income and reduce your taxable income. Any excess above the $3,000 can carry forward to future tax years.
Capital gains taxes can be postponed by using the income to invest in a similar property type.2 However, make sure to consult the IRS website or your tax professional before moving forward on any like-kind exchange, as the requirements are strict and investment types have changed over the years.
Make sure you plan and prepare to protect your investments from higher tax rates. When selling an investment, or even a piece of property, make sure to consult your tax advisor to help determine how much you could be taxed.