Capital gains taxes are levied on the profits made from selling certain types of assets, including stocks, bonds, real estate and other investment properties. If you sell an asset for more than you paid for it, the profit is considered a capital gain, and depending on how long you held the asset and your income, you may owe taxes on that gain. Understanding how capital gains taxes work is essential for making informed financial decisions.

What Are Capital Gains?

A capital gain occurs when you sell a capital asset (like real estate, stocks or other investments) for more than its original purchase price. For example, if you bought stock for $1,000 and later sold it for $1,500, your capital gain is $500.

• Short-Term Capital Gains:
  • These gains arise when you sell an asset you’ve held for one year or less.
  • Short-term capital gains are taxed at your ordinary income tax rates, which range from 10% to 37% (depending on your income level).
• Long-Term Capital Gains:
  • These gains occur when you sell an asset you’ve held for more than one year.
  • Long-term capital gains benefit from preferential tax rates, which are typically lower than ordinary income tax rates.

How Capital Gains Are Calculated

To calculate the amount of capital gains you owe taxes on, you need to determine your cost basis in the asset (how much you paid for it) and then subtract that from the sale price.

• Cost Basis:
  • This is typically the purchase price of the asset, plus any additional costs such as commissions, fees or improvements made to the property (in the case of real estate).
• Capital Gain Calculation:
  • Once you have your cost basis, subtract it from the sale price to determine the gain. For example:
  • Purchase price of asset (cost basis): $10,000
  • Sale price of asset: $15,000
  • Capital gain: $15,000 - $10,000 = $5,000
• Adjustments to the Cost Basis (for Real Estate):
  • If you’ve made improvements to a property, such as renovations or additions, these costs can be added to the cost basis and reduce your taxable gain.
• You may also subtract certain selling expenses, like agent commissions, from your sale price.

Exclusions & Exceptions

In some cases, you may be able to exclude or reduce the capital gains tax liability:

• Exclusion of Gain on Sale of Primary Residence:
  • If you meet specific requirements, you may be able to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of your primary residence.
  • To qualify, you must have owned and lived in the home for at least two out of the last five years..
• Qualified Small Business Stock (Section 1202):
  • Gains on the sale of stock in a qualified small business may be partially or fully excluded from capital gains tax, depending on how long you’ve held the stock and the size of the business.
• Investing in Opportunity Zones:
  • Opportunity zone investments may allow you to defer taxes on capital gains until 2026 and even exclude certain gains from tax if the investment is held for a specified period.

Tax Planning Strategies for Capital Gains

There are several strategies to minimize your capital gains taxes:

• Hold Investments for the Long Term:
  • By holding an investment for more than one year, you can take advantage of long-term capital gains tax rates, which are usually significantly lower than short-term rates.
• Use Tax-Advantaged Accounts (IRA, 401(k), etc.):
  • If you hold assets in a tax-advantaged retirement account, such as an IRA or 401(k), you won’t owe capital gains taxes on the investments until you withdraw them.
  • Roth IRAs and Roth 401(k)s allow for tax-free withdrawals of qualified distributions, including capital gains.
• Offset Gains with Losses (Tax-Loss Harvesting):
  • Tax-loss harvesting involves selling investments that have lost value to offset taxable gains. If your losses exceed your gains, you can use the remaining losses to reduce up to $3,000 of other income ($1,500 if married filing separately).
• Consider Your Filing Status and Tax Bracket:
  • If you’re in a lower tax bracket, you may benefit from the 0% tax rate on long-term capital gains. You can reduce your taxable income by timing the sale of assets or using deductions and credits.
  • Capital gains taxes can have a significant impact on your investment returns, so it’s essential to understand how they work and plan accordingly. We’re here to offer assistance and advice.