Definition, 2022 tax rates, examples


  • Capital gains are profits derived from the sale of a good: financial investments, real estate, movable property or collectibles.
  • Capital gains are either long-term or short-term, depending on how long you’ve held the asset (more or less than a year).
  • Short-term capital gains are taxed as ordinary income, while long-term capital gains are taxed at special and lower rates.

Whether you have a well-maintained brokerage account or a do-it-yourself Robinhood portfolio, the taxman comes for all of us. The IRS treats investments differently based on their type, how long they’ve been held, and their taxable income.

While it’s important to understand how your investments are taxed on tax day, it’s also important to consider these rules when making investment decisions throughout the year.

What are capital gains?

Your capital gains are the profits you make by selling capital assets.

The IRS considers almost everything you own, except property used in a business, to be capital property. This may include:

  • Stocks, bonds and other investments like cryptocurrency
  • Your home or vacation property
  • Items for personal use, such as clothing, household furniture, and jewelry
  • Collectibles such as coins, stamps, antiques, NFTs and works of art
  • Cars, motorcycles, boats and other vehicles

Each asset has a cost base, which is usually what you paid for the asset, plus the money you invested to improve it.

When you sell a fixed asset, the difference between the sale price and your cost base is either a gain (if the sale price is higher than your base) or a loss (if the sale price is lower at your base).

For example, let’s say you buy 100 shares of a stock for $120 per share. Your base in stock is $12,000. Later, you sell the 100 shares for $145 per share, or $14,500. Your capital gain would be $2,500.

Capital Gains Tax Basics

When you sell a capital asset, the gain (or loss) is classified as either short-term or long-term, depending on how long you held the asset before the date of sale.

If you own an asset for more than a year before selling it, there is usually a long-term capital gain or loss. If you’ve owned it for a year or less, the gain or loss is short-term.

Why is this important? Because how long you hold the asset determines the tax rate you pay on your profit – the capital gain.

Short-term capital gains tax rates

Short-term capital gains are taxed at the same rate as ordinary taxable income. Your short-term capital gains tax rate is in the regular tax brackets, which range from 10% to 37%. Below is the short-term capital gains rate based on your filing status and income level:

Long-term capital gains tax rates

With long-term capital gains, things get more interesting. They benefit from special tax rates. And in most cases, these are less than the tax bite incurred by your ordinary income and short-term gains.

There are three basic tax rates: 0%, 15% and 20%. These brackets are applied based on your total taxable income, not the size of the capital gain itself. For 2022 and 2021, the long-term capital gains rates are as follows:

Special capital gains tax rules

The tax rates in the tables above apply to most assets, including most investments. But you should be aware of a few rules and exceptions.

  • Long-term capital gains on collectibles (such as antiques, coins, stamps or works of art) are taxed at a rate of 28%.
  • Capital losses from the sale of personal property are not deductible. So if you sell your home or vehicle for less than you paid, you can’t claim a deduction.
  • Although they pay 20% capital gains tax, high-income investors may also have to Tax on net investment income. A separate tariff, it applies an additional 3.8% tax on all investment income, including capital gains. NIIT affects single taxpayers with a modified adjusted gross income greater than $200,000 or married couples filing jointly with a modified adjusted gross income greater than $250,000.
  • If you inherited capital property, your holding period is automatically long-term, regardless of when the person who bequeathed it to you purchased it.
  • When you sell your home, you don’t have to pay tax on the first $250,000 of the gain from the sale. This exclusion is doubled to $500,000 for married couples filing jointly. To qualify, you must have owned and used the home as your primary residence for at least two of the past five years.

Calculation of capital gains: an example

the


capital gains tax

The rate does not apply item by item, but to your overall net capital gains.

Assume you are a single taxpayer with the following stock trades in 2020:

  • A-share: long-term capital loss of $4,000
  • B-share: long-term capital gain of $7,000
  • C-share: short-term capital loss of $5,000
  • D-share: short-term capital loss of $3,000

To calculate your net gain or loss, you must first calculate your long-term and short-term sales, to arrive at a net result.

  • Long term: ($4,000) + $7,000 = gain of $3,000
  • Short term: ($5,000) + $3,000 = loss of $2,000

With a long-term net gain of $3,000 and a short-term net loss of $2,000, you have a net capital gain of $1,000.

Now assume that your total taxable income for 2020 was $50,000. Using the long-term capital gains tax brackets above, you see that you will only pay 15% on this gain.

Since your ordinary


income tax

is 22%, by taking advantage of lower tax rates on capital gains, you saved $70 in taxes ($150 versus $220 on a capital gain of $1,000).

On the other hand, if you had a long-term gain on the A and B shares and a short-term gain on the C and D shares, the long-term rate would apply to the long-term gain, and your rate ordinary tax applies to the short-term gain.

Tax loss harvest

Maybe the market had a tough year and you end up making a net loss on your investments. You can offset the ordinary income tax of $3,000 as a single filer or as a joint filer. If you are married and file separately, you can offset $1,500. If you have lost more than that, your net losses are carried over to the next year.

Investors who were trying to offset capital gains with their losses could sell their investments at a loss and then buy them back immediately, which is called a wash sale. They could capture that loss with no real damage to their portfolio, until the IRS implements the wash sale rule, which requires you to wait 30 days before redeeming to realize those losses.

Although this rule applies to most securities, it has not yet been applied to cryptocurrency, which means that a fictitious sale of cryptocurrency is still possible.

The bottom line

Tax planning should never be the only determining factor in an investment strategy, but it can be a factor. If possible, holding your investments for more than a year before even thinking about selling them can be a big advantage when it comes to paying taxes on your capital gains.

If you need to cash out certain investments — for an IRA distribution or simply because you need the income — the special capital gains tax treatment can also help you determine which particular holdings to sell and when. Obviously, you would sell the ones that are considered a long-term gain, for the lower tax rate.

But whether you sell your assets after a few months or a few years, be sure to keep good records of what you bought and sold, when the transaction took place, and how much you paid or received for it. This way, you will have all the information you need to correctly calculate and report your capital gains and losses on your tax return.

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