Capital gains is a fancy word for the profits you made from selling your investment or real estate assets. While this term and what surrounds it may seem pretty straight forward, the tricky part of it comes down to how capital gains are taxed. If you have investments, real estate, collectibles, and stocks in a small business then pay close attention.
selling price – purchase price = capital gain / loss
Simply put, if your asset, such as your home, increases in market value your equity would have grown but it is not called capital gains just yet. You’ve got the increase in value on paper but capital gains are only recognized once you sell the asset and have converted it to cash. So, if you purchased your home for $250,000 and you sell it for $320,000, the capital gains are $70,000.
$70,000 of profits is great! But don’t get ahead of yourself because a piece of that belongs to Uncle Sam…
Before you jump in excitement by the gains you realized, we need to have my favorite conversation…taxes (I hope you caught my sarcasm). Knowing the basic IRS rules can keep you out of trouble and make you better prepared for your financial planning.
When it comes to investments, securities, and other assets, the tax rate will vary depending on your taxable income and the length of time you held on to the stocks. The time frame is defined by either short term (one year or less) or long term (more than one year and less than five years). The longer you hold on to your investments, you may be able to pay less taxes on the capital gains.
Also, depending on your taxable income and the asset you sold, you may be taxed anywhere between 0% – 28%.
0% Capital Gains
This is interesting because you don’t have to pay taxes on capital gains if you are one of the following:
- single or married filing separately with maximum taxable income of $37,650
- married filing jointly with maximum taxable income of $75,300
- head of household with maximum taxable income of $50,400
This could definitely help out retirees that have no taxable income…hmmm!
15% Capital Gains
This tax rate on the capital gains applies to tax payers that are between 25% – 35% income tax brackets.
20% Capital Gains
Once you fall into the wealthier tax payers and you’re in the 39.6% tax bracket, you pay 20% on capital gains.
- single with taxable income of $415,051 or more
- head of household with taxable income of $441,001 or more
- married filling jointly with taxable income of $466,951 or more
28% Capital Gains
What I found surprising with our tax code is that small business stocks and collectibles are taxed at 28%! Here is a list of collectibles the IRS considers to be taxed at 28%:
- precious metals
In my opinion, just keep your collectibles! It’s probably a cool hobby or piece of asset you can pass down to your family. 🙂
Minimize Capital Gains with these Exclusions
The only cool thing about the IRS is that they allow you to exclude the capital gains you earned from your home sale. To qualify, you must have owned and lived in the home as your main residence for over 2 years before the sale. You’ll get a sweet deal because you can exclude up to $250,000 of the capital gains. In other words, that profit you made will be TAX FREE!!! It gets better because if you are married and file jointly because the benefit doubles to $500,000! You see, there are some benefits to being married, LOL.
Another way to minimize your capital gains taxes is by investing in 401(k) plans, individual retirement accounts, and 529 college savings accounts because the investments grow tax free or tax-deferred. Obviously, there is a huge tax advantage with these accounts as opposed to having a brokerage account where you are paying capital gains taxes for the stocks and funds you’ve sold.
The bottom line is to fully understand the concept of capital gains and to navigate the system to minimize your tax bill. If you’re worried about your capital gains and the potential tax liability you have a good problem! Setup the right accounts with tax advantages and stay closely in touch with the IRS rules that allow you to exclude capital gains.