What to Know About Capital Gains Taxes
Tax season can be overwhelming and confusing, but understanding your capital gains taxes doesn’t have to be! There is no one-size-fits-all answer when it comes to this type of taxation—after all, each person's tax situation is unique. However, there are some basics that every U.S. taxpayer should know about capital gains taxes and how they may affect them.
In this post, we'll explore what exactly a capital gain is and the different capital gains tax rates that could impact you this filing season.
What are capital gains?
Individuals and businesses recognize capital gains when they sell a capital asset, such as stocks, bonds, mutual funds, real estate, business property, or other investments.
A capital gain is a profit earned on the sale of an asset above its basis. In most cases, it is the difference between the selling price and the cost of purchasing that asset.
What assets are subject to capital gains taxes?
Capital gains taxes may apply to a wide range of assets, including:
- Stocks, bonds and other investments
- Real estate, including personal residences
- Business property
- Jewelry, artwork, and other collectibles
Capital gains taxes are generally levied when an asset is sold for more than the original purchase price, and the difference between the two prices is considered a capital gain. You have a capital loss if you sell the asset for less than your basis.
What is the capital gains tax rate for 2022?
The tax rate you'll pay on capital gains depends on the type of asset you sell and how long you own the asset.
Capital gains tax rates generally fall into two buckets:
Short-term capital gains
Short-term capital gains refer to the profits from selling an asset held for one year or less. These gains are taxed at your ordinary income tax rates—the same rate you'll pay on other types of income, such as wages from a job or income from self-employment.
Your ordinary income tax rate depends on your tax bracket. Tax brackets are determined by income level and filing status. The current federal income tax brackets in the United States range from 10% to 37%, with high-income taxpayers paying higher rates than those with lower incomes.
Long-term capital gains
Long-term capital gains refer to the profits from selling an asset held for more than one year. These gains are generally taxed at a lower rate than short-term capital gains. The long-term capital gains tax rates are 0%, 15%, and 20%, depending on the taxpayer’s income level and filing status.
Capital gains tax rate on collectibles
The capital gains rate on collectibles can be confusing because a special tax rate applies. In general, the federal government treats the sale of collectibles like any other investment, meaning that the gain or loss from selling them is subject to capital gains tax. However, the Internal Revenue Service (IRS) has established some special rules for certain collectibles.
If you sell a collectible you've held for one year or less, it will be taxed at your ordinary income tax rate. However, if you held the collectible for longer than one year, the tax rate on your gain will be 28% (or your ordinary income tax rate, if lower).
How to report capital gains on your tax return
Reporting capital gains taxes on your tax return is a relatively simple process. Still, it’s essential to understand the terminology and rules that apply to ensure you accurately report any gains or losses.
When it comes to reporting capital gains taxes, there are several forms you need to know about.
- 1099-B. If you sell stocks, bonds, and other investments, you should receive a Form 1099-B from your brokerage. This form provides information about your transactions, including a description of the item sold, the date you bought it, the date you sold it, your cost basis, and the proceeds from the sale. You will receive a copy of Form 1099-B directly. Not all capital gains may be reported on Form 1099-B. For example, if you sell a piece of jewelry for more than you paid, you must report the sale to the IRS and pay capital gains tax, but you won't receive a 1099-B.
- 1099-S. Form 1099-S is used to report the sale or exchange of real estate. For example, if you sell your home, you may receive a 1099-B from the title company. This doesn't necessarily mean you owe taxes on the sale—we'll discuss the home sale exclusion below—but you will need to report the sale to the IRS.
- Schedule D. Schedule D is the main form used to report capital gains and losses on an individual tax return.
- Form 8949. Form 8949 is a supplement for Schedule D. If you had multiple capital gains transactions during the year, you'll need to report the details of each sale on Form 8949, then carry the totals to Schedule D.
While it's helpful to understand the kinds of sales that generate capital gains, you generally don't need a deep understanding of how to report them on your tax return. When you file your taxes with Taxfyle, you are connected with one of our Tax Professionals who can help you with your unique tax needs.
How to reduce or avoid paying capital gains taxes
Finding out you owe capital gains tax can take the excitement out of buying low and selling high. But fortunately, several strategies can help you reduce your capital gains tax burden or avoid them entirely.
Net capital losses against capital gains
Netting capital gains and losses is a way to reduce your capital gains taxes by offsetting any gains with losses from other investments. When you net capital gains, you subtract the total amount of your capital losses from your capital gains for the year. This can help you lower the amount of tax you owe or even result in a refund.
If your capital losses are greater than your capital gains, you can offset up to $3,000 of your ordinary income with capital losses. Any capital losses beyond that cap must be carried forward to the next tax year.
Hold your investments for the long term
Holding onto investments for over one year can provide many benefits, the most significant being the favorable long-term capital gains tax rate. By holding onto investments for at least one year and one day, you can benefit from the lower capital gains taxes that apply to long-term investments and minimize the tax you'll owe.
Take advantage of the home sale exclusion
The home sale exclusion is a form of tax relief that allows homeowners to exclude a portion of their capital gains from taxation. Generally speaking, homeowners can exclude up to $250,000 of the taxable capital gains earned from selling their primary residence or up to $500,000 for married couples filing jointly.
To qualify for the home sale exclusion, you must meet the ownership and use tests. This means you must have owned and used your home as your primary residence for at least two out of the five years prior to the date of sale.
Invest in tax-deferred retirement plans
Investing in tax-deferred retirement plans can be an effective way to avoid capital gains taxes. Investing in a qualified retirement plan, such as a 401(k) or IRA, allows your money to accumulate without being taxed until it’s withdrawn. This can help you maximize the growth of your investments over time and reduce your overall tax burden.
Make sure you're calculating your basis correctly
Calculating your basis for capital gains is an important process that can help determine how much you owe in taxes. This is the amount you will use to calculate the capital gain or loss when you sell the asset.
But other costs can increase your basis, and many investors overlook these costs and wind up overpaying their capital gains.
For example, if you paid a commission when you purchased an investment, that commission is part of your basis. And if you own a piece of real estate, any improvements you make to the property increase your basis.
When it comes to reducing or avoiding capital gains taxes, there are several strategies you can use to keep more of your money. Taxfyle's network of Tax Pros can help you find the best strategy for your personal situation and help you save money on your next tax return.
How can Taxfyle help?
Selling assets may affect your tax return. In some cases, you’ll wind up paying more than you thought. But there are ways to navigate this process without headaches. At Taxfyle, we connect you with a CPA or EA who can help you file your tax return properly.
Don’t worry about trying to understand the complicated tax codes and forms. Our Pros have the experience necessary to handle your unique tax situation without you needing to lift a finger. This tax season, don’t file your tax return yourself; have a Pro do the work for you.