Understanding the Capital Gains Tax
What is the Capital Gains Tax?
The capital gains tax is a tax paid on profits from the sale of a significant asset or investment—otherwise known as a capital asset. Capital assets include items like homes, rental property, furniture, stocks, bonds, and collectibles—pretty much anything you can buy, own, and sell.
The IRS defines “short-term” as holding an asset for one year or less before selling and “long-term” as holding the asset for more than one year. If you hold onto a capital asset for more than a year before selling it at a profit, when tax season rolls around you’ll pay a lower capital gains tax rate because the federal government taxes long-term capital gains at a lower rate than it taxes short-term capital gains.
Capital Gains Tax Rates
1. Short-Term Capital Gains
In the case of a short-term capital gain, you’ll pay taxes at a rate equivalent to your ordinary income tax rate. The 2019 ordinary income tax brackets for single filers are as follows (and there are comparable tax brackets for married couples filing separately and jointly and for heads of households):
- 37% for incomes over $510,300
- 35% for incomes over $204,100
- 32% for incomes over $160,725
- 24% for incomes over $84,200
- 22% for incomes over $39,475
- 12% for incomes over $9,700
- 10% for incomes of $9,700 or less
By taxing short-term capital gains at the same rates as ordinary income, the IRS effectively privileges long-term investments over short-term investments. Keep this in mind when you purchase a capital asset with the intent to sell it. Merely “flipping” an investment tends to lead to a hefty tax bill at the end of the year.
2. Long-Term Capital Gains
For long-term capital gains, you’ll pay a generally lower tax rate based on several factors:
- your filing category (single, married and filing jointly, etc.),
- your annual income, and
- the type of asset sold.
In general, long-term capital gains get taxed at a much lower (and simpler) rate than short-term capital gains: at either 0%, 15%, or 20%. The following chart breaks down these figures by tax category and annual income:
|Tax Rate||Single||Married Filing Jointly||Head of Household|
|0%||$0 – 39,375||$0 – 78,750||$0 – $52,750|
|15%||$39,376 – 434,550||$78,751 – 488,850||$52,751 – 461,700|
|20%||$434,551 or more||$488,851 or more||$461,701 or more|
Importantly, you’ll determine if a sale is a gain or a loss by calculating your capital asset’s “basis.” Your basis is usually just what you paid to acquire the capital asset—both the sale price and additional expenses that went along with it. However, a capital asset’s basis can change if you do anything to increase the asset’s value (such as improving a home) or if the asset’s value depreciates over time.
Offsetting Gains with Losses
If you have a capital loss from an investment (such as stocks and bonds), you can often use that capital loss to offset capital gains and reduce your tax burden. This option, however, doesn’t apply to a capital loss that results from the sale of personal property.
Selling Your Home
Additionally, you will not need to pay all or most of the capital gains tax on the sale of your home if you meet the following criteria:
- You owned in the home for at least two of the five years prior to selling it;
- The home was your primary residence for at least two years out of that same five-year period (and this two years doesn’t need to be continuous); and
- You haven’t already excluded the capital gain when selling a different home within the two years preceding the sale.
If you satisfy these conditions, then up to $250,000 of the profit from the sale of your home is tax-free if you’re single—a limit that goes up to $500,000 if you’re married and you and your spouse file a joint tax return.
The IRS will expect you to report both capital gains and capital losses on your federal tax return. This typically involves submitting Form 1040 (your actual tax return) and two additional documents: Form 8949 and the Form 1040 Schedule D. Form 8949 allows you to provide a detailed list of each of your transactions involving capital assets for the year, figure out if those transactions collectively amount to a gain or a loss, and then transfer those totals to your Schedule D.