What is Capital Gains Tax?
Capital gains tax is a mandatory fee, charged by the government when a person sells an asset (e.g., shares or property) for a profit.
🤔 Understanding capital gains tax
When you profit from an investment, you should probably know how much goes to the government. Capital gains tax applies to both individuals and businesses. It's payable when a capital asset (e.g., stocks, bonds, real estate) is sold, and a gain is realized.
Capital gains fall into two categories: short-term and long-term. Short-term capital gains — profits on assets held less than one year — are taxed as ordinary income. For instance, if you’re in the 24% federal tax bracket, you’ll pay taxes at that rate, or even higher if the gain bumps you into the next tax bracket. Typically, long-term capital gains are treated more favorably. They’re “realized” when an asset is sold after being held for more than one year, and depending on your tax bracket, the long-term capital gains tax rate is either 0%, 15%, or 20%.
Let’s assume an investor bought shares in the fictional company Alma’s Almanacks less than one year ago, and their market value has risen steadily. The investor decides to sell the stock. As they have held the shares for less than one year, the investor would be subject to short-term capital gains tax, which is taxed at the same rate as their personal income. However, if the investor sells their shares for a profit after more than one year, they would be subject to a reduced capital gains tax (ranging from 0% to 20%, depending on the investor’s income tax bracket). State taxes may vary.
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When do you owe capital gains tax?
Calculating capital gains tax is relatively straight-forward. Let’s assume an investor owns a capital asset (shares, bonds, property), and they decide to sell:
- If the sales price is higher than their purchase price, then there is a potential capital gain. It's important to note that commissions and fees are included in the cost basis.
- The next step is to determine how long the investor has held the asset.
- If they have owned the asset for less than one year, then they will need to pay capital gains tax at the same rate as normal income tax. Note: There are some exceptions to this rule, such as with collectibles (like stamps, coins, and baseball cards), which may be taxed at a higher rate.
- If the investor has held the asset for more than one year, then their profit will be taxed differently. The tax will now range from 0% to 20%, depending on the investor’s annual income. State taxes may vary.
Remember, capital losses may help offset capital gains. If an investor has lost money in the current year, or in previous years, then that may help offset against some gains. This can reduce how much the investor has to pay in taxes.
What are the current capital gains tax rates?
Short-Term Capital Gains Tax
An investor who owns shares or property for one year or less before selling for a gain falls into this category. The gain is taxed the same as regular income.
For an individual, these rates are as follows for 2022 (taxes due spring 2023) and 2023 (taxes expected to be due in spring 2024):
| Capital gains tax rate | 2022 Taxable income | 2023 Taxable income |
| 10% | $0 to $10,275 | $0 to $11,000 |
| 12% | $10,276 to $41,775 | $11,001 to $44,725 |
| 22% | $41,776 to $89,075 | $44,726 to $95,375 |
| 24% | $89,076 to $170,050 | $95,376 to $182,100 |
| 32% | $170,051 to $215,950 | $182,101 to $231,250 |
| 35% | $215,951 to $539,900 | $231,251 to $578,125 |
| 37% | $539,901 and up | $578,126 and up and up |
Long-Term Capital Gains Tax
Someone who holds stock or property for more than one year before selling for a profit will be deemed a long-term investor, and their tax rate might be significantly reduced.
For an individual, here's the breakdown of long-term capital gains tax rates for 2022 (taxes due spring 2023) and 2023 (taxes due spring 2024):
| Capital gains tax rate | 2022 Taxable income | 2023 Taxable income |
| 0% | $0 to $41,675 | $0 to $44,625 |
| 15% | $41,676 to $459,750 | $44,626 to $492,300 |
| 20% | $459,751 and up | $492,301 and up |
Property Sales Tax
If a single person lives in a property and they sell it for a profit, then there is no tax on up to a $250,000 gain ($500,000 if married).
This capital gains tax exemption does not apply if the individual has not lived in the house (i.e., it’s an investment property), is living overseas, or has not owned or lived in the house for 2 years in a 5-year period preceding the sale date.
A homeowner who has already used their $250K / $500K CGT tax credit in the last two years will not be able to apply for the exemption.
Are there strategies that can reduce capital gains tax?
Yes, there are some strategies to reduce capital gains tax. Here are a few examples.
Gifts
Family gifts can be used to reduce a capital gains tax bill. Each year a family member can give up to $15,000 to another family member as a gift. A married couple can give up to $30,000. So, if you give an asset that has appreciated to a family member who's in a lower tax bracket, together you can minimize the tax burden on your family.
Loss taking
An investor who has capital losses or carried over capital losses from previous years may be able to reduce their capital gains tax.
Just Hold On
An obvious alternative to paying short-term capital gains tax is to just hold onto your investment. Typically, after the one-year mark, a person’s capital gains tax liability is significantly reduced. Of course this should be considered in context with your overall investment strategy
Disclosure
Robinhood does not provide tax advice. Please consult with a tax professional regarding your personal circumstances.
New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.
