About capital gains taxes in 2023
What are capital gains, and how are they taxed?
Investing can be a great way to grow your wealth, but it's important to understand the tax implications, especially when it comes to capital gains.
Any time you sell an investment, such as real estate, stocks, bonds or precious metals, for a profit, you can bet the government wants its cut, too. Still, if you take a hit and sell your investment for less than you paid for it, you can report the loss for some tax benefit, too.
We'll explain what capital gains are, how they work and how they can impact your taxes.
Key insights
- Capital gains are profits earned from the sale of assets, such as stocks, real estate or cryptocurrency.
- Capital gains can be offset by capital losses, and any excess capital losses can be carried forward to future tax years.
- There are strategies to minimize the tax impact of capital gains, such as tax-loss harvesting.
What is capital gains tax?
Capital gains tax is a form of taxation where individuals or businesses pay taxes on the profit earned from the sale of a capital asset. This type of asset can include stocks, bonds, real estate, artwork and other capital investments.
When an asset is sold for more than its purchase price, the amount of money gained becomes known as a capital gain. In order to calculate how much tax is owed from this gain, several factors must be considered, such as the type of asset that was sold, how long it was held prior to being sold and the taxpayer’s tax bracket.
Long-term capital gains tax
Short-term capital gains tax
Short-term capital gains tax rates are typically higher than long-term capital gains tax rates because short-term gains are considered part of an individual's regular income and are therefore taxed at the same rate as the rest of their income.
How does capital gains tax work?
Taxpayers use IRS Form 1040 to report capital gains and losses. Those with larger incomes may be required to make quarterly estimated tax payments. Otherwise, you pay your capital gains taxes when you file your annual taxes. For the most up-to-date information about reporting, visit the IRS page about Schedule D.
Capital Gain =
Selling Price − Purchase Price
The seller’s filing status, tax bracket and the length of time the asset was held are used to calculate the capital gains tax. These tax rates can be as high as 37%. Watch out for two things: tax exemptions and net investment income tax (NIIT).
- Capital gains tax exemption: In some circumstances, the IRS offers a capital gains tax exemption for the sale of your primary residence. To be eligible, you must have lived in the home for at least two years before the sale date.
- NIIT: Net investment income includes capital gains and income from rentals, royalties and nonqualified annuities. According to the IRS, NIIT rates apply at 3.8% to some individuals, estates and trusts.
How to minimize your capital gains tax
There are strategies to minimize your capital gains tax, such as charitable giving, using tax-advantaged accounts like an individual retirement account (IRA), and tax-loss harvesting.
Tax-loss harvesting is when you sell poor investments that have lost value for a capital loss. This capital loss can help offset capital gains.
Other strategies include buying and gifting your investments at the right time. “Do not purchase active mutual funds late in the year,” said Glen Goland, JD, CFP, senior wealth strategist at Arnerich Massena. “These funds often distribute capital gains sometime in December, so it is best to wait until after the record date to purchase the shares.”
Goland also suggested making your charitable gifts with appreciated stocks rather than cash. “Gifts of stock essentially write the IRS out of the equation, since the charitable entity is exempt from tax on the gains that arise when the charity sells the stock that has been gifted to them.”
» MORE: How to file back taxes
Long-term capital gains tax rates
The long-term capital gains tax rates and brackets below are currently used by the IRS.
For short-term capital gains, use the current federal income tax brackets to determine your rate.
| Tax rate | Single | Married filing separately | Married filing jointly | Head of household |
|---|---|---|---|---|
| 0% | $0 to $41,675 | $0 to $41,675 | $0 to $83,350 | $0 to $55,800 |
| 15% | >$41,675 to $459,750 | >$41,675 to $258,600 | >$83,350 to $517,200 | >$55,800 to $488,500 |
| 20% | >$459,750 | >$258,600 | >$517,200 | >$488,500 |
In exceptional cases, the tax rate for long-term capital gains can surpass 20%. This can happen if you are selling a Section 1202 qualified small business stock or are selling collectibles such as art or coins.
» MORE: What is excise tax?
FAQ
Who pays capital gains tax?
The specific tax brackets in the tables above pay taxes on most capital gains. However, some types of capital gains, like the sale of a primary residence, might not be taxed.
Do states charge capital gains tax, too?
Most states levy taxes on capital gains. State-level capital gains taxes can range from 0% to around 13%.
Are seniors exempt from capital gains tax?
There is no exemption for seniors on capital gains taxes. However, capital gains on some assets are exempt already, such as primary residences up to a specific gain amount.
How can I avoid capital gains tax?
You can potentially minimize or avoid capital gains tax by selling capital assets after you've retired, investing within a tax-deferred retirement plan or offsetting capital gains with capital losses. For real estate sales of primary residences, homeowners are exempt from capital gains taxes on the first $250,000 of the sale’s capital gain if they are single and $500,000 if they are married and filing a joint return. This exemption can only be used once every two years.
Bottom line
Capital gains can be an important source of investment income, but they can also trigger tax liabilities that can diminish your profits. By understanding how capital gains taxes work, you can make informed investment decisions that help you maximize your after-tax returns.
Article sources
- IRS, " Topic No. 409 Capital Gains and Losses ." Accessed Feb. 21, 2023.
- IRS, " Topic No. 701 Sale of Your Home ." Accessed Feb. 21, 2023.
- IRS, " Questions and Answers on the Net Investment Income Tax ." Accessed Feb. 21, 2023.
- IRS, " About Schedule D (Form 1040), Capital Gains and Losses ." Accessed Feb. 21, 2023.
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