Long-term capital gains tax: Things to know

One way to profit from an asset or investment (like a piece of real estate or some stocks) is by selling it. In most cases, you’ll need to pay taxes on the money you make when selling real estate, stock or other types of investments. Typically, the tax is based on the difference between the price you paid for the asset or investment and what it sold for.

But the amount of tax you’ll be responsible for can vary based on how long you owned the asset and how much money you make from disposing of it. In most cases when you’ve owned an asset or investment for more than a year, you’ll pay what’s known as the “long-term capital gains tax.”

Let’s look at what exactly this tax is, how much it costs, who must pay it, and what you need to keep in mind before tax time.

• What is the long-term capital gains tax?
• What is a capital gain?
• What are the tax rates on long-term capital gains?
• How could this affect my taxes?

What is the long-term capital gains tax?

The long-term capital gains tax is the federal government’s method of taxing the money that someone makes when selling an asset that they’ve owned for personal or investment purposes for more than a year. These assets could be cars, jewelry, stocks or even household furnishings.

The capital gains tax rate is typically lower than what you pay on other forms of income. That’s because the government wants to give you incentives to invest, especially in long-term investments. More investment and business activity can lead to economic growth.

Minimizing capital gains tax

Understanding the long-term capital gains tax and how it works can help you keep more of your money when taxes are due. You may be able to time the sale of your property to reduce your tax liability — or see if you qualify for an exception that allows you to skip the taxes altogether.

What is a capital gain?

A capital gain or loss refers to the difference between the amount of money you paid for a capital asset (known as its adjusted basis) and what you received when you sold it. If you made money on the sale, it’s considered a capital gain. If you lost money, it’s considered a capital loss. Sometimes you can take a tax write-off for capital losses — but not always. You should check the rules for deducting capital losses if you’re thinking of claiming the deduction.

For example, say you purchase stock shares for $100,000. In five years, you sell those shares for $200,000. You’ll likely pay a long-term capital gains tax on the $100,000 in profit.

Investments in stocks or bonds and most types of property you have for personal purposes are considered capital assets.

When do you realize a capital gain?

You typically don’t record a capital gain or loss until you sell the asset. In the tax year you make the sale, you’re required to report a description of the property sold, the amount you paid for it, the sale price, the date of the sale and your gain or loss on the sale.

Important exceptions in capital gains taxes

While most property being sold is treated the same way, there are important differences for some common types of sales. Here are two examples.

1. Selling your home — If you make money selling your primary residence, you may not have to pay a capital gains tax on it. IRS rules exempt the first $250,000 in profit on the sale of a primary residence for an individual tax filer and $500,000 for a married couple filing jointly. You’ll need to meet certain requirements for how you’ve used the home and how long you owned it and lived there before selling it.

2. Small-business stock — If you sell a portion of a small business, there’s a chance you’ll be able to exempt some or all of the profit you made when selling – but only if you and your business meet a host of qualifications.

Long-term vs. short-term capital gains

Whether a capital gain or loss is classified as long-term or short-term depends on how long you’ve owned the asset that was bought and sold.

According to the IRS, a capital gain is generally classified as long-term if you owned the asset for more than a year at the time you sold it. If you owned the asset for exactly one year or less on the day you sold it, the resulting gain or loss is classified as short-term.

If you’re considering selling an asset and want to minimize the federal tax impact of a capital gain, it’s important to know which days the IRS counts in determining if a capital gain is short-term or long-term. You’ll want to count from the day after you purchased the asset up to and including the day you sold it.

Keep in mind that there are a few exceptions to this rule. For example, dividends on mutual funds and REITs, or real estate investment trusts, are considered long-term capital gains no matter how long you’ve owned the investments. Money made when selling inherited property is also always considered a long-term capital gain, no matter how long you held it.

What are the tax rates on long-term capital gains?

For most tax filers, long-term capital gains are taxed at a 15% rate or less. But the rate varies depending on your income.

This chart outlines the tax rate on capital gains based on your taxable income for the year and tax filing status. If you make less than the amount shown, you’ll pay the long-term capital gains tax rate in that row.

You’ll notice that these rates are much different from the tax rates on other types of income.

Exceptions to these tax rates

While most capital gains are taxed at the above rates, there are some exceptions.

Gains on the sale of collectibles — like antiques, rugs, artwork, stamps or coins — are taxed at a 28% rate.

Gains on the sale of qualifying small-business stock can also face a higher tax rate. While there are exemptions discussed above, whatever part is taxable will be hit with the higher 28% tax rate.

Short-term capital gains tax rates

If your capital gain is a short-term gain rather than a long-term gain, you may pay a higher tax rate.

Short-term capital gains are treated as ordinary income. This means they’ll be taxed at your standard tax bracket — which ranges from 10% to 37%, depending on your income.

How could this affect my taxes?

If you’re selling capital assets like stocks or real estate (other than rental property) during the year, you should be prepared to pay taxes on the profit of the sale. Plan ahead and set aside some of the proceeds to cover your tax liability.

Depending on the sale, you may need to make estimated tax payments to avoid a penalty. If you expect to owe more than $1,000 in taxes on Tax Day, you likely need to make an estimated tax payment ahead of time. This worksheet from the IRS can help you determine if you need to make an estimated tax payment or not.

Not paying all the tax you owe by the time it’s due can mean you face interest and possibly penalties on the unpaid balance.

Bottom line

Whether it’s through selling stock at a much higher price than you paid to buy it, making a killing in real estate or cashing in on some other investment, congrats on the payoff! But remember that the IRS expects you to pay tax on most types of income — unless it’s specifically exempt by law. That includes your gains from the sale of capital assets.

Getting up to speed on the tax impact of capital gains can help you avoid an unexpected tax bill and possible underpayment or late-payment penalties at the end of the year.

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She codeveloped an online DIY tax-preparation product, serving as chief operating officer for seven years. She is an Enrolled Agent and the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s degree in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.