Capital Gains Tax
Contents
- Understanding the Capital Gains Tax
- How Does the Capital Gains Tax Work?
- Long-Term vs. Short-Term Capital Gains
- Capital Gains Tax Rates in 2021 and 2022
- Special Capital Gains Rates and Exceptions
- Calculating Your Capital Gains
- Capital Gains Tax Strategies
- When Do You Owe Capital Gains Taxes?
- How Can You Avoid Capital Gains Taxes?
- What Is Good About Reducing the Capital Gains Tax Rate?
- What Is Bad About Reducing the Capital Gains Tax Rate?
- Article Sources
Understanding the Capital Gains Tax
The capital gains tax is a levy on the profit from an investment that is incurred when the investment is sold. It applies only after an investment is sold, not while it's still held, and it's only applicable to "capital assets" such as stocks, bonds, real estate, and collectibles. When an asset is sold for a profit, that profit is considered a capital gain, and it's taxed at different rates depending on how long the asset was held.
How Does the Capital Gains Tax Work?
The capital gains tax is applied to the profit made from selling an investment. This tax is only realized when the investment is sold, and it's not incurred while the investment is still held. For example, if you purchase shares of stock and sell them later at a higher price, the difference between what you paid and what you sold them for is considered a capital gain.
Long-Term vs. Short-Term Capital Gains
In the United States, the capital gains tax rate differs depending on how long the asset was held. Assets held for more than a year are subject to long-term capital gains tax rates, which are typically lower than short-term capital gains tax rates. Short-term capital gains apply to assets held for one year or less and are taxed at the individual's regular income tax rate, which is usually higher than the long-term capital gains tax rate.
Capital Gains Tax Rates in 2021 and 2022
The capital gains tax rates for long-term capital gains vary depending on the taxpayer's filing status and taxable income. In 2021, these rates ranged from 0% to 20%, while in 2022, they ranged from 0% to 20% as well. The tax rates are adjusted annually for inflation.
Special Capital Gains Rates and Exceptions
Certain categories of assets receive different capital gains tax treatment than others. For example, gains on collectibles are taxed at a flat rate of 28%, regardless of the taxpayer's income. Additionally, there are special rules for owner-occupied real estate and investment real estate that can affect the calculation of capital gains tax.
Calculating Your Capital Gains
Capital gains tax can be calculated by subtracting any capital losses from capital gains to determine the net gain or loss for the year. This calculation can become more complex if there are both short-term and long-term investments involved, but there are tools available, such as capital gains calculators, to help simplify the process.
Capital Gains Tax Strategies
There are several strategies that investors can use to minimize their capital gains tax liability. These include holding onto assets for more than a year to qualify for lower long-term capital gains tax rates, using capital losses to offset gains, and taking advantage of tax-advantaged retirement plans to avoid capital gains tax altogether.
When Do You Owe Capital Gains Taxes?
You owe capital gains taxes for the year in which you realize the gain, meaning when you sell the asset for a profit. These taxes are reported on a Schedule D form and are subject to different rates depending on the length of time the asset was held.
How Can You Avoid Capital Gains Taxes?
While it's not possible to entirely avoid capital gains taxes, there are several strategies that investors can use to minimize their tax liability. These include holding onto investments for more than a year, utilizing capital losses to offset gains, and taking advantage of tax-advantaged retirement accounts.
What Is Good About Reducing the Capital Gains Tax Rate?
Proponents of reducing the capital gains tax rate argue that it incentivizes investment and economic growth by allowing investors to keep more of their profits. They also argue that it prevents double taxation since the money used to purchase assets has already been taxed as ordinary income.
What Is Bad About Reducing the Capital Gains Tax Rate?
Opponents of reducing the capital gains tax rate argue that it primarily benefits the wealthy and exacerbates income inequality by taxing passive income at a lower rate than earned income. They also argue that it encourages tax sheltering and speculation rather than productive investment.