Perhaps nothing in taxes can raise sheer terror or confusion like the words “Capital Gains Tax.” We know it must be something very, very bad – but we’re just not quite sure WHAT it is, or WHY it is “bad.” Well, you’re in luck – we’re here to shed light on the dark, mysterious world of capital gains.
The truth is, “capital gain” is actually a good thing. Capital gain is a rise in the value of an investment or real estate asset that results in it having a higher value than its purchase price. The asset owner does not realize these gains until the asset is sold.
A short-term capital gain is profit that has been realized on an asset held for one year or less.
A long-term capital gain is profit realized from the sale of an asset held for more than one year.
Both types of capital gain must be claimed on income taxes. Long-term capital gain tax rates are 0%, 15%, or 20% depending on your taxable income and your filing status. Capital gains tax rules can vary from state to state.
Is there such a thing as “Capital Loss?”
Yes, there is. Capital gains can occur on any security, real estate, stock, or fund that’s sold for a price higher than its purchase price. When the asset is sold, the tax laws are triggered. Gains that show up on paper, but do not trigger taxation because the gains have not been realized, are often referred to as paper gains.
The same laws apply to capital losses – those unfortunate times when an asset depreciates in value, showing it is now worth less than its purchase price.
It’s important to be aware of your capital gains and losses. For example, if you invest in mutual funds, you or your tax advisor should determine your potential fund’s unrealized accumulated capital gains before investing in it. This is referred to as the fund’s capital gains exposure. It’s important because when distributed by the fund, the fund’s capital gains are a taxable obligation for you, the investor.
The difference between your capital gains and your capital losses is called your “net capital gain.” If losses exceed gains, you can deduct the difference on your tax return.
Short-term capital gains, occurring usually on investments held for one year or less, are taxed as ordinary income based on your tax filing status and adjusted gross income. Long-term capital gains, however, are traditionally taxed at a lower rate than regular income.
To determine what tax rate applies to your capital gain; you must include your capital gain in your income. Capital gains taxes are progressive, much like income taxes.
How the TJCA changes rules for capital gains
The expansive reforms in the Tax Cuts and Jobs Act (TCJA) include some changes when it comes to capital gains. For 2018 through 2025, tax brackets on long-term capital gains won’t be tied to ordinary income tax brackets. The tax rates on long-term capital gains remain the same:
Single Filers: Pay a 0% tax rate on income from $0 to $38,600. The tax rate increases to 15% on gains from $38,601 to $425,800. It increases to 20% over $425,801.
Married People Filing Joint Returns: From $0 to $77,200 they pay a 0% rate. From $77,201 to $479,000 they pay a 15% tax rate. And the 20% rate kicks in from $479,001 and up.
Head of Household: From $0 to $51,700 they pay a 0% rate. From $51,701 to $452,400 they pay a 15% tax rate. And the 20% rate kicks in from $452,401 and up.
Trusts and Estates: From $0 to $2600 there is a 0% tax rate. From $2601 to $12,700 there is a 15% tax rate. And the 20% rate kicks in from $12,701 and up.
For 2018 through 2025, trust and estate rates and brackets will be used to calculate the tax that applies to children and young adults who collect long-term capital gains.
Short-term gains will be taxed at ordinary income tax rates from 2018 through 2025.
You can offset capital gains taxes.
Investment capital losses can be used to offset capital gains. Let’s say you sold a stock for a $10,000 profit this year, but sold another stock at a $4000 loss. You would then be charged on capital gains of $6000 – the difference between the two.
Some conclusions on the TCJA and Capital Gains
Under the TCJA, single filers must earn at least $500,000 and married couples filing jointly must earn at least $600,000 to qualify for the highest ordinary-income tax bracket.
But lower incomes now can qualify for the higher 20% tax on long-term capital gains (such as real estate or funds): gains of over $425,800 for single people or $479,000 for married couples, etc. This means, unfortunately, that people in the 35% ordinary-income tax bracket may have to pay the highest 20% tax rate on long-term capital gains.
Another new feature of the TCJA designed to help investors avoid capital gains tax is an investment vehicle called “Qualified Opportunity Funds (QOF)”. These direct resources to low-income communities, labeled “Opportunity Zones.” Capital gains and losses can be complex – and can add up. Don’t hesitate to call us for advice, especially if you’re selling a home. There are strategies you can use to avoid or reduce capital gain taxes on your home sale.