If you own investments (such as stocks, a rental property, or even cryptocurrency) or sell an asset you own (such as that art collection you’ve been curating), it’s crucial to understand how capital gains taxes work so you’re not caught off guard when tax season rolls around.
What are Capital Gains?
A capital gain is the profit you make from selling an asset. If you buy something and sell it for more than you paid, that’s a capital gain—and the IRS is eager to get a cut.
Keep in mind, the IRS doesn’t care if your gains are accidental or intentional—if you make a profit, you’re paying taxes on it.
The good news is that not all capital gains are taxed equally, and with the right strategy, you can reduce what you owe.
The Long and Short of It
There are two types of capital gains: short-term capital gains and long-term capital gains.
Short-Term Capital Gain: Any profit is taxed as ordinary income if you sell an asset you’ve held for less than a year. That means it’s subject to the same tax rates as your salary or business income, which could be as high as 37% depending on your tax bracket.
Long-Term Capital Gain: If you’ve held the asset for over a year, congratulations! You qualify for the long-term capital gains tax rate, which is much more favorable.
Losses Have Limits, Gains Do Not
There are no limitations on gains—meaning if you make a huge profit on an asset sale, you’ll owe taxes on all of it.
But what if your investments didn’t go as planned?
If you sell an asset at a loss, you can use those losses to offset your gains. This is called tax-loss harvesting, and it’s one of the best tools in your tax-saving toolbox.
However, there’s a limit to how much you can deduct: you can use capital losses to offset capital gains dollar-for-dollar but if your losses exceed your gains, you can only deduct up to $3,000 ($1,500 if married filing separately) against other income.
The good news? If your losses exceed that $3,000 limit, you can carry them to future tax years.
So, if you had a rough year on the stock market, there’s always hope for next year’s tax return!
For high-income earners, the idea is to close the gap between the tax rates on ordinary income and long-term capital gains. Currently, the 20% rate is the highest you’ll face, but future changes could push that up, making tax planning even more crucial.
If you need an update on your tax plan and strategy, we’re here to help.