Capital Gains Tax 101

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Capital Gains Tax 101
Long-Term Capital Gains Tax Rates for 2022
Filing Status0%15%20%
SingleUp to $41,675$41,676to $459,750Over $459,750
Head of householdUp to $55,800$55,801to $488,500Over $488,500
Married filing jointly or surviving spouseUp to $83,350$83,351 to $517,200Over $517,200
Married filing separatelyUp to $41,675$41,6751to $258,600Over $258,600

Although marginal tax rates have fluctuated over time, the maximum tax on regular income has virtually always been much higher than the highest rate on capital gains, as this chart from the Tax Policy Center indicates.

Tax Policy Center

Not all capital gains are taxed at the normal 0%/15%/20% rate. Here are some examples of situations in which capital gains may be taxed at rates greater than 20%:

  • Gains on collectibles, like as paintings and stamp collections, are taxed at a maximum rate of 28%.
  • The taxable part of gain on the sale of Section 1202 stock is additionally taxed at a maximum rate of 28%.
  • Any unrecaptured Section 1250 gain from the sale of Section 1250 real property is taxed at a maximum rate of 25%.

Home Sale Exclusion

Capital gains on the sale of a primary home are taxed differently than other forms of real estate due to a unique exception. Essentially, if you sell your primary residence and make a capital gain, you may deduct up to $250,000 of that gain from your income if you owned and resided in the residence for two years or more in the previous five years. The exclusion for married couples filing jointly is $500,000.

Net Investment Income Tax

Some taxpayers are liable to the net investment income (NII) tax in addition to the standard capital gains tax. It levies an extra 3.8% tax on your investment income, including capital gains, if your modified adjusted gross income (MAGI) exceeds:

  • $250,000 if married filing jointly, or $250,000 if an eligible widow(er) with a child.
  • $200,000 whether you are single or the head of a household
  • if married filing separately, $125,000

How to Calculate Long-Term Capital Gains Tax

Most people calculate their taxes (or have professionals do it for them) utilizing software that does the calculations automatically. To obtain an idea, you may also utilize a capital gains calculator. There are many free calculators accessible online. If you wish to do the math yourself, here’s the fundamental formula for computing capital gains tax:

  Energy Tax Definition

  1. Determine your foundation. In most cases, the basis is the purchase price plus any commissions or fees you paid. For stock splits and dividends, the basis may be modified up or down.
  2. Calculate your realized profit. This is the selling price less any commissions or fees.
  3. To calculate the difference, subtract the basis (what you paid) from the realized value (what you sold it for). This is referred to as capital gain (or loss).
  4. Calculate your tax. If you have a capital gain, multiply it by the applicable tax rate to calculate your capital gains tax on the asset (remember that tax rates differ depending on your taxable income and how long you held the asset before you sold it).You may be able to utilize a capital loss to offset capital gains if you have one.

How to Minimize or Avoid Capital Gains Tax

There are many strategies to reduce or even eliminate capital gains taxes. Here are five of the most prevalent strategies:

1. Invest for the long term

You will pay the lowest capital gains tax rate if you locate exceptional firms and retain their shares for a long time. Of course, saying this is simpler than doing it. The fortunes of a business might change over time, and there are several reasons why you might want or need to sell sooner than you thought.

2. Take advantage of tax-deferred retirement plans

When you invest in a retirement plan, such as a 401(k), 403(b), or individual retirement account (IRA), your money grows without being taxed right away. You may also purchase and sell assets inside your retirement account without being taxed on the capital gains.

While you take money from a typical retirement plan, your gains will be taxed as regular income, although you may be in a lower tax band than when you were working. The money you remove from a Roth IRA account, on the other hand, is tax-free—as long as you follow the regulations.

  2022 Federal Income Tax Brackets, Standard Deductions, Tax Rates

Investors nearing retirement may want to wait until they cease working before selling assets outside of these accounts. If they have a low enough retirement income, their capital gains tax bill may be decreased or they may be able to avoid paying any capital gains tax. However, if they are already in one of the “no-pay” categories, there is an important consideration to bear in mind: If the capital gain is significant enough, it may raise their total taxable income to the point where they may face a tax charge on their profits.

Capital losses may be used to offset both capital gains and a part of your regular income. Any remaining funds may be carried over to future years.

3. Use capital losses to offset gains

If you have an investment loss, you may use it to reduce the tax on your profits from other assets. Assume you hold two stocks, one of which is worth 10% more than you purchased for it and the other is worth 5% less. If you sold both equities, the loss on one would offset the capital gains tax due on the other. Obviously, in a perfect world, all of your assets would increase in value, but losses sometimes occur, and this is one method to gain from them.

If your capital losses exceed your capital gains, you may deduct up to $3,000 of the difference from your taxable income for the year. After that, you may carry the loss forward to subsequent tax years until it is depleted.

4. Watch your holding periods

If you’re selling a security that you acquired roughly a year ago, be sure you know the transaction date. Waiting a few days or weeks to qualify for long-term capital gains treatment may be a prudent option if the price of the investment remains reasonably stable.

5. Pick your cost basis

When you buy and sell shares in the same firm or mutual fund at various periods and prices, you must calculate your cost basis. Although most investors compute cost basis using the first in, first out (FIFO) approach, there are four more ways available: last in, first out (LIFO), dollar-value LIFO, particular share identification, and average cost (only for mutual fund shares).

  Schedule K-1: Beneficiary's Income, Deductions, Credits

If you’re selling a large amount of stock, you should check with a tax professional to establish which approach is best for you.

Will I Owe Capital Gains Tax if I Sell My Home?

You will not have to pay capital gains tax on the sale of your house if your gain is less than $250,000 (or $500,000 if you are married filing jointly). To qualify for the exemption, you must have resided in the house for at least two of the preceding five years (which is allowable once every two years).If your gain exceeds the exemption limit, you must pay capital gains tax on the difference.

How do I Calculate My Basis in a Capital Asset?

The foundation for most assets is your capital investment in the asset. It is your purchase price plus any other expenditures you spent, such as commissions, recording fees, or transfer fees, for example. Your modified basis may then be computed by adding any expenditures you’ve expended for extra upgrades to your basis and subtracting any depreciation you’ve already deducted and any insurance reimbursements you’ve received.

Will Capital Gains Tax Rates Change for 2022?

The capital gains tax rates in 2022 will be the same as they were in 2021: 0%, 15%, or 20%, depending on your income. The greater your rate, the larger your revenue. While the tax rates stay the same in 2022, the income necessary to qualify for each band rises to account for inflation. The highest zero-rate taxable income amount for married filing jointly and surviving spouses is $83,350, for heads of household it is $55,800, and for married filing separately it is $41,675.

The Bottom Line

Although the tax tail should not wag the whole financial dog, it is critical to consider taxes as part of your investment plan. Reduced capital gains taxes, for example, by keeping assets for more than a year before selling them, is a simple method to enhance your after-tax earnings.

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