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What Is Capital Gains Tax?

What Is Capital Gains Tax?

5 Minute Read

If you’ve spent any time hanging out with investors or accountants, the term capital gains tax has probably come up once or twice. More than likely you have a good idea of what income taxes are—the money Uncle Sam takes out of your paycheck every couple of weeks—but what are capital gains? What are capital gains taxes?

What Is the Capital Gains Tax?

Simply put, the capital gains tax is the tax the government charges on profits from the sale of an asset such as a share of stock or a piece of property.

It works like this:

Let’s say you buy a piece of land for $25,000. Later, you sell that same piece of land for $75,000. The profit you make—in this case, $50,000—is a capital gain. You bought an asset, the asset increased in value, and you sold it for more than you paid for it.

Easy, right?

This is a super simple example of a capital gain. But it helps to know what a capital gain is, because the way the IRS taxes them is actually pretty complicated.

Depending on how long you own the asset in question, and in some cases, what kind of asset you own that’s gone up in value, it may be taxed at a different rate—or it could be exempt from taxes altogether.

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That’s because long-term capital gains and short-term capital gains are taxed at different rates, and some capital gains are exempt up to a certain amount. (There’s always a magic number.)

Let’s take a look!

Long-Term Capital Gains Tax

If you buy something—let’s say it’s a share of stock—keep it for at least one year, and then sell it for more than you originally bought it for, that’s a long-term capital gain.

Long-term capital gains are taxed at special rates—starting at 0% (i.e., you don’t owe any taxes) and maxing out at 20%—based on your taxable income. The tax brackets for 2019 break down like this:1

Long-Term Capital Gains Tax Rates

Rate

Individuals

Married filing jointly

Head of household

0%

$0–39,374

$0–78,750

$0–52,749

15%

$39,375–434,549

$78,750–488,849

$52,750–461,699

20%

$434,550 and up

$488,850 and up

$461,700 and up


These income thresholds are indexed to inflation, which means as the cost of living goes up, the amount you earn before the tax bracket kicks in also goes up.2

There is also a separate, Net Investment Income Tax (NIIT) of 3.8% that is charged on capital gains for people whose Modified Adjusted Gross Income (MAGI) is over $200,000 ($250,000 for married filers).3 This amount doesn’t change with inflation.

If you sell your house, that is also a capital gain, but depending on how long you’ve lived there your profit may actually be tax-exempt. Here’s the thing: It has to be your main residence (i.e., where you live full-time, not the lake house), and you have to have lived in the house for at least two years of the previous five to exempt up to $250,000 in home sale profit (this goes up to $500,000 for married couples).4 This means you don’t pay any taxes on it, capital gains or otherwise! That’s awesome! You can claim this exemption once every two years.

Short-Term Capital Gains Tax

Short-term capital gains are taxed differently. If you’ve owned the asset in question for less than one year, the profit from the sale is taxed at the normal, personal income tax rate.

When you file your taxes for 2019, the top rate is 37% for individual single taxpayers with incomes greater than $510,300 ($612,350 for married couples filing jointly).5 The rest of the rates are:

  • 10% for incomes of $9,700 or less ($19,400 for married couples)
  • 12% for incomes over $9,700 ($19,400 for married couples)
  • 22% for incomes over $39,475 ($78,950 for married couples)
  • 24% for incomes over $84,200 ($168,400 for married couples)
  • 32% for incomes over $160,725 ($321,450 for married couples)
  • 35% for incomes over $204,100 ($408,200 for married couples)

It’s important to note that the NIIT of 3.8% also applies to short-term capital gains.

What Is the Capital Gains Tax Rate for 2020?

For 2020, there’s no change to the long-term capital gains tax rate. The short-term capital gains rate, however, is still the same as the personal income tax rate, which is indexed to inflation.

The top tax rate is 37%, but it kicks in for individual single taxpayers with incomes greater than $518,400 ($622,050 for married couples filing jointly).6 The other rates also remain the same, but the thresholds are:

  • 10% for incomes of $9,875 or less ($19,750 for married couples)
  • 12% for incomes over $9,875 ($19,750 for married couples)
  • 22% for incomes over $40,125 ($80,250 for married couples)
  • 24% for incomes over $85,525 ($171,050 for married couples)
  • 32% for incomes over $163,300 ($326,600 for married couples)
  • 35% for incomes over $207,350 ($414,700 for married couples)

Find a Guide for Your Tax Journey

This is a lot to keep track of, so it may make sense to get a tax pro to help you crunch these numbers. Our tax Endorsed Local Providers (ELPs) are great at helping people figure out what to do come tax time.

Not only can they help you prepare your return, but our ELPs can help you plan for the future, walking you through your withholdings to make sure you’re getting the biggest possible paycheck while not also getting stuck with an unexpected tax bill come April.

Find your pro today!

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