Long-Term vs. Short-Term Capital Gains: What’s the Difference?

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Long-Term vs. Short-Term Capital Gains: What’s the Difference?
Tax Rates for Short-Term Capital Gains 2022
Filing Status10%12%22%24%32%35%37%
SingleUp to $10,275$10,276 to $41,775$41,776 to $89,075$89,076 to $170,050$170,051 to $215,950$215,951 to $539,900Over $539,900
Head of householdUp to $14,650$14,651 to $55,900$55,901 to $89,050$89,051 to $170,050$170,051 to $215,950$215,951 to $539,900Over$539,900
Married filing jointlyUp to $20,550$20,551 to $83,550$83,551 to $178,150$178,151 to $340,100$340,101 to $431,900$431,901 to $647,850Over $647,850
Married filing separatelyUp to $10,275$10,276 to $41,775$41,776 to $89,075$89,076 to $170,050$170,051 to $215,950$215,951 to $323,925Over $323,925

Source: Internal Revenue Service

Ordinary income is taxed at graded rates based on your earnings. A short-term capital gain (or a portion of one) may be taxed at a higher rate than your normal earnings. This is because it may cause a portion of your total income to be taxed at a higher marginal rate.

In our previous scenario, using the 2021 federal income tax rates and assuming you file as a single person, you would be in the 22% tax bracket with your taxable salary income. However, due to the progressive structure of the federal tax system, the first $9,950 you make is taxed at 10%, income from $9,951 to $40,525 is taxed at 12%, and income from $40,526 to $86,375 is taxed at 22%.

Part of your $10,000 capital gain, up to the $86,375 bracket maximum, would be taxed at 22%. However, the remaining $3,625 gain would be taxed at 24%, the rate for the next highest tax bracket.

If you’re having problems understanding how capital gains influence your tax bracket and your tax burden, seek the advice of an accountant or other financial specialist.

Capital Gains and State Taxes

Where you reside determines whether you must additionally pay capital gains taxes to the state. Some states tax capital gains, whereas others either do not tax them or treat them favorably. The following states do not have income taxes, and hence no capital gains taxes:

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

A credit, deduction, or exclusion is available in some states. Colorado, for example, provides an exclusion for real or physical property, whereas New Mexico provides a deduction for federally taxable profits. Montana includes a credit that may be used to offset a portion of any capital gains tax. Beginning January 1, 2022, Washington state will impose a 7% tax on long-term net capital gains in excess of $250,000.

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Which Assets Are Counted as Capital Gains?

Some assets receive different capital gains treatment or have different time frames than the rates indicated above.

Collectibles

You’re taxed at a 28% rate—regardless of your income—for gains on art, antiques, jewelry, precious metals, stamp collections, coins, and other collectibles.

Qualified Small Business Stock

The tax status of qualifying small business (QSB) stock is determined by when it was bought, who acquired it, and how long it was kept. The stock must have been obtained from a QSB after August 10, 1993, and the investor must be a noncorporate entity that owned the shares for at least five years to qualify for this exemption.

A QSB is commonly described as a domestic C company whose total gross assets have never surpassed $50 million since August 10, 1993. The quantity of cash held by the firm, as well as the adjusted bases of all other property owned by the corporation, are included in aggregate gross assets. Furthermore, the QSB must submit all mandatory reports.

Only specific sorts of businesses are classified as QSBs. QSBs may be found in the technology, retail, wholesale, and manufacturing sectors, but not in the hospitality, personal services, financial sector, farming, or mining.

Originally, this exemption permitted the taxpayer to deduct 50% of any gain from the sale of QSB shares. However, it was subsequently raised to 75% for QSB stock purchased between February 18, 2009, and September 27, 2010, and to 100% for QSB stock purchased after September 27, 2010. The gain that is eligible for this treatment is limited to $10 million or 10 times the stock’s adjusted basis, whichever is greater.

Home Sale Exclusion

If you sell your primary house, you may take advantage of a particular capital gains arrangement. The first $250,000 of an individual’s capital gains on the sale of their primary property is exempt from taxable income ($500,000 for married couples filing jointly), as long as the seller owned and resided in the home for two of the five years before the sale. Because capital losses on the sale of personal property, including your house, are not tax deductible, if you sold it for less than you paid for it, this loss is not deductible.

A single taxpayer, for example, who bought a property for $300,000 and sold it for $700,000 received a $400,000 profit on the transaction. They must declare a capital gain of $150,000 after using the $250,000 exemption. This is the sum that is liable to capital gains tax.

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Significant repairs and renovations may usually be added to the original price of the home. These may help to minimize the amount of taxable capital gain even more. If you spend $50,000 to install a new kitchen to your house, you could deduct that amount from the initial $300,000 purchase price. The overall base cost for capital gains computations would rise to $350,000, but the taxable capital gain would fall from $150,000 to $100,000.

Investment Real Estate

Real estate investors are often permitted to deduct the depreciation of their real estate assets from their total taxable income. This deduction is intended to represent the property’s gradual degradation as it ages, and it effectively decreases the amount you’re regarded to have paid for the property in the first place. This also increases your taxable capital gain when you sell the property.

For example, if you bought $200,000 for a building and are eligible for $5,000 in depreciation, you will be considered as if you spent $195,000 for the facility. If you later sell the property, the $5,000 is considered recapturing the depreciation deductions. The recovered sum is subject to a 25% tax rate.

So, if you sold the building for $210,000, your total capital gains would be $15,000. However, $5,000 of that amount would be viewed as a recapture of the tax deduction. That recovered amount is taxed as regular income, although it is limited at 25%. The remaining $10,000 in capital gain would be taxed at one of the above-mentioned rates of 0%, 15%, or 20%.

Investment Exceptions

High-income individuals may be subject to an additional tax on capital gains: the net investment income tax. This tax adds 3.8% to your investment income, including capital gains, if your MAGI exceeds specified thresholds: $250,000 if you’re married and filing jointly or a surviving spouse, $200,000 if you’re single or a head of household, and $125,000 if married and filing separately.

Advantages of Long-Term Capital Gains

It may be beneficial to retain assets for a longer period of time if they will be liable to capital gains tax when they are realized.

Most persons will pay less tax if they realize a capital gain after one year. Assume you purchased 100 shares of XYZ Corp. stock for $20 per share and sold them at $50 per share. Your yearly wages income is $100,000, and you file taxes jointly with your spouse. The graphic below shows the taxes you’d pay if you sold your shares after more than a year vs less than a year.

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How Patience Can Pay Off in Lower Taxes
Transactions and consequencesLong-term capital gainShort-term capital gain
Bought 100 shares at $20$2,000$2,000
Sold 100 shares at $50$5,000$5,000
Capital gain$3,000$3,000
Capital gainstax$450 (taxed at 15%)$660(taxed at 22%)
Profit after tax$2,550$2,340

By electing a lengthy investment gain and being taxed at long-term capital gains rates, you would pay $450 of your earnings. However, if you had held the shares for less than a year (resulting in a short-term capital gain), your profit would have been taxed at your regular income tax rate. For our $100,000-a-year couple, it would result in a 22% tax rate, which is the appropriate rate for income exceeding $81,051 in 2021. This adds another $210 to the capital gains tax obligation, bringing the total to $660.

While it is possible to earn a better return by cashing out your assets regularly and reinvesting the proceeds in other investment possibilities, that higher return may not compensate for higher short-term capital gains taxes. Churning is the process of constantly changing investment holdings, resulting in significant capital gains tax and commission payments.

Are long-term capital gains rates going up in 2022?

Despite legislative changes, capital gains will not increase in 2022. The United States House Ways and Means Committee presented their proposal for tax-raising legislation in September 2021. The plan includes an increase in the highest long-term capital gains tax from 20% to 25%. The plan was designed to take effect on September 13, 2021, which means that transactions performed before to that date would still be subject to the 20% rate, while those completed after that date would be subject to the 25% rate.

How do I calculate capital gain on the sale of property?

You must first identify your ownership interest in the property. Your basis is the initial purchase price plus any fees paid, less any depreciation. Determine your realized amount next. Your realized amount is the price you sold the property for less any fees you paid. Finally, subtraction your base from your realized amount is required. If the number is positive, you will have realized a capital gain. If the number is negative, you will experience a capital loss.

Will my long-term capital gains push me into a higher ordinary income tax bracket?

Your long-term capital gains will not result in a higher tax rate on your regular income. Regular income is computed and taxed separately at ordinary income rates. More long-term capital gains may drive you into a higher tax rate (0%, 15%, or 20%), but they will have no effect on your regular income tax bracket.

However, if you had short-term capital gains, your ordinary income would rise, possibly pushing you into the next marginal ordinary income tax rate.

The Bottom Line

Long-term capital gains are virtually always taxed at a lower rate than short-term capital gains. The majority of taxpayers are not required to pay the highest long-term rate. Tax policy encourages you to keep capital gain assets for a year or longer.

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