What Is A Capital Gains Tax And How Much Is It?
Capital gains taxes are the taxes that an individual or business pays on the profits they make when they sell a capital asset, such as an investment, a business, or real estate. The amount of tax owed on the sale of the asset is based on the difference between the asset's selling price and its original purchase price. In the United States, capital gains taxes are generally paid at the federal and state levels.
The federal capital gains tax rate varies depending on the type of asset sold and the length of time it was held. Generally, long-term capital gains—gains on assets held for more than a year—are taxed at a lower rate than short-term capital gains, which are gains on assets held for a year or less. The federal tax rate for long-term capital gains can range from 0% to 20%, depending on a person's income. The federal tax rate for short-term capital gains is the same as the taxpayer's ordinary income tax rate.
In addition to federal capital gains taxes, taxpayers may also face state capital gains taxes. In most states, the tax rate for long-term capital gains is the same as the taxpayer's ordinary income tax rate. However, some states have adopted more favorable tax rates for long-term capital gains. For example, in California, the long-term capital gains tax rate is 13.3%, while the ordinary income tax rate is 11.3%.
The amount of capital gains taxes an individual or business will owe also depends on their income. For example, taxpayers in the highest tax bracket may pay a maximum federal rate of 20%. However, taxpayers in the lowest tax bracket may pay a federal rate of 0% on long-term capital gains. Taxpayers in the middle tax brackets may pay a federal rate of 15%.
It is also important to note that certain types of capital gains may not be subject to capital gains taxes. For example, some types of investments, such as municipal bonds, are exempt from capital gains taxes. In addition, certain types of assets, such as inherited property, may be exempt from capital gains taxes. Finally, certain types of investment income, such as qualified dividends, may be subject to special tax rates.
In addition to taxes on capital gains, taxpayers may also be subject to the net investment income tax. This tax is generally imposed on taxpayers with a modified adjusted gross income of $200,000 or more for single filers, or $250,000 or more for married couples filing jointly. The net investment income tax is 3.8% of the taxpayer's net investment income.
Capital Gains Tax Planning Strategies
There are several strategies that taxpayers can use to reduce their capital gains taxes. For example, taxpayers may want to consider selling their investments at the end of the year in order to take advantage of the lower tax rates for long-term capital gains. Taxpayers may also want to consider investing in assets with lower capital gains taxes, such as municipal bonds or qualified dividends. In addition, taxpayers may want to consider investing in assets that are exempt from capital gains taxes, such as inherited property.
Taxpayers may also want to consider utilizing capital losses to offset capital gains. When a taxpayer has a capital loss, they can use the loss to offset any capital gains they have. The amount of the capital loss that can be used to offset gains is limited to $3,000 per year. Any unused capital losses can be carried over to future years. Finally, taxpayers may want to consider investing in tax-advantaged accounts, such as 401(k)s, IRAs, and HSAs, which can help reduce their taxable income.
Conclusion
Capital gains taxes can be complicated and vary depending on the type of asset sold, the length of time it was held, and the taxpayer's income. However, by understanding how much capital gains taxes are and taking advantage of tax-advantaged accounts, taxpayers can reduce their tax liability. Taxpayers should also consider utilizing capital losses to offset capital gains and taking advantage of more favorable tax rates for long-term capital gains.