If you own a capital asset, such as a piece of real estate or a stock, and you sell it for a profit, the Internal Revenue Service will want to collect a tax on your gain.
However, the IRS charges different rates depending on how long you've owned the asset and your taxable income.
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What Are Capital Gains?
A capital gain is the amount an asset increases in value between the time you bought it and the time you sold it. Conversely, you'll have a capital loss if you sell the asset for less than the amount you paid for it.
The IRS starts with an "adjusted basis" to calculate the amount of capital gain. Usually, the "adjusted cost basis" is only the amount you paid when you bought it.
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What Are Long-term Capital Gains?
Long-term capital gains are the profits you make on capital assets that you have owned for more than one year.
What Are Short-term Capital Gains?
Short-term gains are profits you have made on investments that you have owned for one year or less.
How to Calculate Capital Gains
Suppose you bought 10 shares of Company A at $50 per share, for a total purchase price of $500. You held the shares for 14 months, and the price went up to $65 per share. If you now sell the stock, you'll realize a long-term capital gain of $150 ($650 less cost of $500) and you'll pay taxes at the long-term rate based on your income level.
Now suppose you've only held the shares of Company A's stock for nine months, and you decided to sell at the current price of $60 per share. In this case, you'll pay taxes on the gain of $100 ($600 less cost of $500) at the ordinary income rate on your federal income tax return.
You'll report your net capital gains on IRS Form Schedule D.
What Are Capital Gains Tax Rates?
The tax rate on gains from the sale of assets depends on the holding period between when you bought the asset and when you sold it. It's either short-term or long-term, and you'll pay taxes on your "net capital gain," which is the difference between your gains and losses.
The short-term capital gains tax rate is based on your ordinary income tax rate. You'll pay the same tax rate for your short-term capital gains as you do for your adjusted gross income. Current regular income tax brackets for tax year 2022 range from 10 percent to 37 percent.
Taxes on a long-term capital gain are typically at a lower rate compared to the rate for short-term gain . The IRS has three brackets of tax rates for long-term capital gains: 0 percent, 15 percent and 20 percent. The long-term capital gains tax rate depends on the level of your adjusted gross income and your taxpayer filing status, whether single, married filing single or jointly or head of household.
There are two exceptions to these rules for rates. Collectibles – such as antiques, precious metals, coins, fine art and stamps – are taxed at a flat 28 percent. And some investors may have to pay an additional 3.8 percent in net investment income tax if their modified adjusted gross income exceeds certain threshold income levels.
Realized vs. Unrealized gains?
If you owned a stock and its price goes up, you don't have to pay a capital gains tax on this increase in value. You'll only pay a tax when you actually sell the asset and book the profit. This is the difference between a realized versus an unrealized gain.
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How to Minimize Capital Gains Taxes
You can avoid paying capital gains taxes if your assets are held in a tax-deferred account, such as an IRA, a Roth IRA or other retirement plans.
If you have a capital gain that is large relative to your other income, it could trigger the Alternative Minimum Tax. If this is the case, you should speak with a professional tax advisor to learn your best strategy to minimize your taxes.