What is Capital Gains Tax?
Capital gains tax (CGT) is a levy that is payable when an asset (e.g., shares or property) is sold for a profit.
Capital gains tax (CGT) applies to both individuals and businesses. It is payable when a capital asset (stocks, bonds, real estate property, jewelry, etc.) is sold, and a gain is realized. Long term capital gains are “realized” when an asset is sold after being held for more than a year. Depending on an individual’s tax bracket, the rate is either 0%, 15%, or 20%. Short term capital gains — on assets held less than a year — are taxed as ordinary income. Capital gains can be offset by capital losses, which are realized when an asset is sold for less than its purchase price.
Let’s assume that an investor bought a property less than a year ago, and the price has risen steadily. They decide to sell the house and capitalize on the profit. As they have held the property for less than the 1 year, they would be subject to short-term CGT, which is taxed at the same rate as personal income. However, if the investor holds the property for more than a year, he or she will be liable for a reduced rate of CGT (typically from 0% to 20%, depending on the investors’ income tax bracket). It is important to note that there also may be state taxes with different rules and rates to take into account.
Capital gains tax is like an income tax for your money...
When you put your money to work in the stock market — or in another type of asset — it doesn’t get to bring home the bacon without the government getting a slice. You can keep the government's slice a little smaller by playing the long game.
Calculating whether you are required to pay capital gains tax is relatively straight forward. Let’s assume that an investor owns a capital asset (shares, bonds, property), and they decide to sell:
An investor who owns shares or property for less than a year 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:
|Taxable income||Capital gains tax rate|
|$0 to $9,325||10%|
|$9,325 to $37,950||15%|
|$37,950 to $91,900||25%|
|$91,900 to $191,650||28%|
|$191,650 to $416,700||33%|
|$416,700 to $418,400||35%|
|$418,400 and up||37%|
Someone who holds stock or property for more than a year before disposing of it for a profit will be deemed as a long-term investor, and the tax rate is significantly reduced.
Here’s the breakdown for individuals:
|Taxable income||Capital gains tax rate|
|$0 to $9,325||0%|
|$9,325 to $37,950||0%|
|$37,950 to $91,900||15%|
|$91,900 to $191,650||15%|
|$191,650 to $416,700||15%|
|$416,700 to $418,400||15%|
|$418,400 and up||20%|
Investment property is treated differently than a main residence. If a single person lives in a property, then there is no tax up to a $250K gain. This also applies to a married couple; however, the amount there goes up to $500K.
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 / $500L CGT tax credit in the last two years will not be able to apply for the exemption.
The short answer is yep. Some of the strategies that can be used to reduce CGT are:
Family gifts can be used to reduce a capital gains tax bill. Each year a family member can give up to $14K to another family member in the form of a gift. A married couple can give up to $28K. So, if you gift the appreciated asset to a family member in a lower tax bracket, and its value is less than the gift tax limit, you can avoid capital gains tax — and the recipient (should they choose to sell the asset) pays taxes at his or her income tax rate.
An investor who has capital losses or carried over capital losses from previous years will potentially be able to reduce their capital gains tax.
Home sweet home! Renovations could mean a significant reduction in capital gains tax.
If your renovations increase the price of your home, they can be added to the cost basis — subject to limits by the IRS.
Insurance and healthcare savings plans can be used to reduce a tax bill. A 529 college savings plan allows the owner to deposit money into the plan and eventually pull it out without triggering a capital gains tax event as long as used for qualified educational expenses. Healthcare savings accounts (‘HSAs) are similar, with the potential growth in the account tax-free.
Relocating interstate is another option for someone who wishes to reduce their capital gains tax. With capital gains tax, there is a federal and state levy. Moving to somewhere like Florida, where there is zero capital gains tax, could mean that only the federal amount needs to be paid. To take advantage, you would need to be a resident of the state before selling the asset.
Just Hold On
An obvious alternative is just to hold on and not sell – particularly if it is the difference between 6 months and a year. Once past the long-term mark of one year, the capital gains tax liability is significantly reduced.
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