You might already be familiar with taxable income and the taxes you pay on your wage. But how do you pay taxes when you sell your home for a profit? That’s when you would enter the territory of capital gains taxes.
You might owe these taxes when you sell assets, such as real estate, collectibles, or stocks, at a profit. On the other hand, capital losses could reduce the tax you owe if you take a loss on a sale. Capital gains tax rules could get complicated, especially if you aren't familiar with them.
Learning your tax brackets and figuring out your responsibilities to the IRS requires knowing what you owe in capital gains taxes. Let’s break it all down.
- What are capital gains taxes?
- What is the difference between long-term vs. short-term capital gains
- Long-term capital gains taxes in 2022
- Short-term capital gains taxes in 2022
- So when do I pay more taxes?
- Pros and cons of long-term capital gains
- Pros and cons of short-term capital gains
- Bottom line
What are capital gains taxes?
Capital gains taxes are a type of taxes that may apply if you make a profit on a capital asset. What exactly is a capital asset? It's assets you own or purchased for personal use or investment purposes.
Say, for example, that you buy a piece of art and the artist gets famous, so you sell the painting for more than you paid for it. The resulting profit would be a capital gain, subject to capital gains taxes.
The specific amount of profit you're taxed on equals the difference between the cost basis and the amount you made from the sale. The cost basis usually refers to the asset's cost, which might equal its purchase price.
However, the basis is adjusted under IRS rules in some cases. This happens, for example, if you inherit property. Your adjusted basis would be the property's value when you inherited it.
To understand how much your capital gains taxes would be, you need to know your basis, the sale price, and your capital gains tax rate. You'll also need to know if your gains are considered long-term or short-term capital gains.
What is the difference between long-term vs. short-term capital gains
Your net capital gains are taxed differently depending on the holding period of the asset.
Long-term capital gains
Typically, if you own the asset for more than a year before selling it, your profits would be considered long-term capital gains. These are taxed at a lower rate than short-term capital gains.
If you own the asset for at least a year and a day, you should be able to qualify for this more favorable rate. For example, if you're looking to avoid capital gains tax on stocks, you could hold them for at least a year to lower how they’re taxed. When you're making a plan for how to invest money, consider the tax implications of different investment strategies.
Short-term capital gains
If you own an asset for less than a year before selling at a profit, you would owe short-term capital gains taxes instead. In this case, you’d pay capital gains taxes at your ordinary federal income tax rate rather than the more favorable long-term capital gains tax rates.
For example, placing your stocks in taxable accounts for less than a year before selling them would mean you’d pay short-term capital gains. Getting taxed at this higher rate could come at a higher cost that eats into the returns you earn from your stocks, mutual funds, exchange-traded funds (ETFs), and other assets.
Long-term capital gains taxes in 2022
As with regular income taxes, capital gains tax rates are higher for top earners. Specific tax brackets are defined depending on your income and tax filing status.
However, long-term capital gains tax rates are lower than ordinary income tax rates. Your long-term capital gains rate is based on your total taxable income, so most people pay 0% or 15% tax on capital gains.
|Long-term capital gains tax rate thresholds when filing as:|
|Single||Married filing separately||Married filing jointly||Head of household|
|0% capital gains tax||Up to $41,675||Up to $41,675||Up to $83,350||Up to $55,800|
|15% capital gains tax||$41,675 to $459,750||$41,674 to $258,600||$83,350 to $517,200||$55,800 to $488,500|
|20% capital gains tax||Over $459,750||Over $258,600||Over $517,200||Over $488,500|
How much long-term capital gains tax will I pay?
Capital gains taxes are somewhat different from income taxes, because the assessed rate applies to all your gains. If you're in the 22% income tax bracket, you'd pay 22% on the part of your income that falls into the 22% bracket. But if you're in the 15% capital gains tax bracket, you'd pay 15% on every dollar of capital gains you make.
You could determine how much you owe in capital gains tax by looking at your rate. For example:
- If you’re single and file a tax return with a taxable income of $40,000 and a $1,000 long-term profit, you'd have a capital gain of $1,000. Your capital gains tax rate would be 0%, and you would pay no capital gains taxes, which gives you tax-free gains.
- If you’re a married couple and file a joint tax return with a total taxable income of $90,000 and a $1,000 long-term profit, you'd have a capital gain of $1,000. Your capital gains tax rate would be 15%, and you would pay $150 in capital gains taxes ($1,000 x 15%).
However, there is a potential exception if you are a high earner. You might owe an additional 3.8% net investment income tax when your income exceeds a certain threshold. This tax includes gains, passive rents, taxable interest, dividends, and royalties.
Net investment income tax might apply to you if:
- You're single and file a tax return with a taxable income above $200,000.
- You’re a married couple and file a joint tax return with a total taxable income above $250,000.
- You’re a married couple and file separate tax returns, each with a taxable income above $125,000.
However, if you have any capital losses, you could deduct that amount to offset your taxes. For example, if you sold a stock at a $500 loss in the same tax year you made a $1,000 gain on a different investment, you would be taxed on just $500 in gains. This strategy is known as tax-loss harvesting.
Short-term capital gains taxes in 2022
Your short-term capital gains rates are usually higher than long-term capital gains rates. You're simply taxed at your ordinary income tax rate. Here's how this looks, depending on your income and filing status.
|Short-term capital gains tax rate thresholds when filing as:|
|Single||Married filing separately||Married filing jointly||Head of household|
|10% capital gains tax||$0 to $10,275||$0 to $10,275||$0 to $20,550||$0 to $14,650|
|12% capital gains tax||$10,275 to $41,775||$10,275 to $41,775||$20,550 to $83,550||$14,650 to $55,900|
|22% capital gains tax||$41,775 to $89,075||$41,775 to $89,075||$83,550 to $178,150||$55,900 to $89,050|
|24% capital gains tax||$89,075 to $170,050||$89,075 to $170,050||$178,150 to $340,100||$89,050 to $170,050|
|32% capital gains tax||$170,050 to $215,950||$170,050 to $215,950||$340,100 to $431,900||$170,050 to $215,950|
|35% capital gains tax||$215,950 to $539,900||$215,950 to $539,900||$431,900 to $647,850||$215,950 to $539,900|
|37% capital gains tax||$539,900 or more||$539,900 or more||$647,850 or more||$539,900 or more|
How much short-term capital gains tax will I pay?
Because short-term capital gains are taxed as ordinary income, the amount you'll pay if you sell an asset at a profit before a year has passed depends on your tax bracket. For example:
- If you’re single and file a tax return with a $40,000 taxable income with $1,000 capital gains, you'd owe a 12% tax on your gains. You would pay $120 in capital gains taxes.
- If you’re a married couple and file a joint tax return with a combined taxable income of $90,000 and $1,000 in capital gains, you’d fall in the 22% tax bracket. You would pay $220 in capital gains taxes.
The additional 3.8% tax for high earners mentioned above also applies to short-term gains as it does to long-term gains. You could also use short-term capital losses to offset short-term gains, no matter how much you earned.
So when do I pay more taxes?
You could potentially be subject to capital gains taxes whenever you sell an asset at a profit. However, the long-term capital gains tax rate is lower than the short-term capital gains tax rate.
In most cases, you may pay 0% or 15% taxes on your capital gains if your gross income is low enough and you hold the assets longer than a year.
If you want to avoid paying more in taxes, you could hold your assets for at least a year and a day if you anticipate making a profit. If that's not possible, then harvesting your losses could make sense to offset some gains. Tax-loss harvesting would mean selling losing assets during the same year when you know you will make a profit that's subject to tax.
It's also important to understand whether any other special rules apply. For example, a special rule applies when it comes to capital gains tax and home sales. Homeowners might get a $250,000 exemption of gains as a single filer or a $500,000 exemption of gains as married joint filers.
This rule applies when they profit from the sale of a property they owned and used as their primary home for at least two years of the five years before the sale.
Pros and cons of long-term capital gains
The biggest benefit of long-term capital gains is that you are taxed at a reduced rate. If you could pay less on your profits to the IRS, you get to keep more of your returns.
Buying assets as long-term investments could also maximize your chances of successful investing. A buy-and-hold strategy has historically paid off more than buying assets with the intent to sell them quickly. This might be due to the difficulty of accurately timing the market if you're chasing short-term profits.
Of course, the downside of long-term capital gains is that you're tying up your money for over a year in an asset. Additionally, if you make a substantial profit and you fear that the asset's value will go down, you may not want to risk your gains by holding onto the asset only to ensure your profit is taxed at a reduced rate.
Pros and cons of short-term capital gains
The benefit of short-term capital gains is that you get to lock in your profits once you've earned them and don't have to wait and hope that the asset's value doesn't go down. You could also access your money more quickly and use it for other purchases or investments rather than leaving it locked up in your assets.
The downside of short-term capital gains is paying more taxes on the profits you make if you haven't held your assets for at least a year. Paying more in taxes means you don't get to keep as much of your money.
Is it worth waiting for long-term capital gains?
In many situations, it might be worth waiting for long-term capital gains. However, the actual answer naturally depends on your situation. You would likely pay a lower tax rate if you wait until your capital gains are considered long-term capital gains.
However, the downside is that you might lose some or all of your profit due to potential asset depreciation. This might happen before you've owned it long enough to be taxed at the lower long-term capital gains rate.
Additionally, you might need the money for other investments or other important financial goals before a year has passed.
Why are long-term and short-term capital gains taxed differently?
Long-term and short-term capital gains are taxed differently by the government to promote long-term investment strategies. Long-term capital gains are taxed at a lower rate with the goal of incentivizing saving and investing while reducing risk-taking.
What is a capital loss?
A capital loss is when you sell an investment or a personal asset for less than the price you paid. Capital losses offset capital gains when you’re calculating your taxes.
Capital Losses come in long-term and short-term forms. Long-term losses could offset long-term gains, while short-term losses could offset short-term gains. If you have more losses than gains, you could have a tax deduction of up to $3,000 per year in capital losses from your ordinary income.
If you enjoy investing and making a profit from stocks, crypto, or other assets, it’s essential to understand how capital gains work. This would allow you to step up your tax planning game and fulfill your obligations to the IRS.
If you aren't sure what you owe on capital gains as a taxpayer, working with a financial advisor or tax professional can be a good idea. A financial advisor could help you reduce your tax bill to keep more of your returns in your pocket.
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