Capital gains tax: the most daunting word in investing. You might have heard a lot about this tax on the news; President Biden wants to increase it. Some of you might be wondering what a capital gains tax is. How much do you need to pay? What are different kinds of capital gains? Here is what you need to know.
What is capital gains tax?
Corporations and many individuals have invested in assets, which could include stocks, bonds, real estate, jewelry and collectibles. These are capital assets, which means they have intrinsic value. Yes, this includes the Pokémon cards you’ve been collecting that are now worth thousands of dollars. It also includes the pen you just bought at Staples. When you sell these assets for more than you paid, it’s called a capital gain. A capital gains tax is a tax on that growth in value.
The value of these assets can fluctuate based on the concept of supply and demand: The more people want something, the more value it incurs and vice versa. So, hypothetically, if your pen goes up in value – for whatever reason – and you sell it, the government wants a piece of that profit. However, one thing to remember is the capital gains tax is only activated when you sell your asset. If you’re holding onto it, you will not be taxed if it goes up in value. These are called realized and unrealized gains.
Long-term vs. short-term capital gains
The capital gains tax amount varies depending on how long you hold onto the asset. When an individual holds onto an asset for more than a year, it’s a long-term capital gain. When that asset is sold in one year or less, it’s a short-term capital gain.
This is important to know because the system is set up to benefit the long-term investor. Short-term investments are almost always taxed more than long-term investments. Why? To encourage people to keep their assets. The economy is more stable when people are holding onto their investments. When an asset is constantly bought and sold, its value is volatile.
Income tax bracket
Short-term capital gain is taxed at a higher ordinary income rate. So, you can pay a high or low short-term capital gains tax depending on your regular income. It also varies if you file single or jointly.
2020 -2021 Income Tax Bracket
|Single||$0 – $9,875||$9,876 – $40,125||$40,126 – $85,525||$85,526 – $163,300||$163,301 – $207,350||$207,351 – $518,400||$518,401 or more|
|Married, Filing Jointly||$0 – $19,750||$19,751- $80,250||$80,251- $171,050||$171,051- $326,600||$326,601- $414,700||$414,701 – $622,050||$622,051 or more|
|Head of Household||$0 – $14,100||$14,101 – $53,700||$53,701 – $85,500||$85,501 – $163,300||$163,301 – $207,350||$207,351 – $518,400||$518,401 or more|
|Married, filing separately||$0 – $9,875||$9,876 – $40,125||$40,126 – $85,525||$85,526 – $163,300||$163,301 – $207,350||$207,351 – $311,025||$311,026 or more|
Long-term capital gains are taxed at a much lower rate. They are taxed at 0%, 15% and 20% depending on your income. Like the regular income tax rate, the long-term capital gains tax varies depending on whether you file single or jointly.
2020 -2021 Long-Term Capital Gains Tax
|Single||$0 – $40,000||$40,001 – $441,450||$441,451 or more|
|Married, filing jointly||$0 – $80,000||$80,001 – $496,600||$496,601 or more|
|Head of Household||$0 – $53,600||$53,601 – $469,050||$469,051 or more|
|Married, filing separately||$0 – $40,000||$40,001 – $248,300||$248,301 or more|
Now that you know where you stand on capital gains tax, is there a way you can avoid or minimize paying these taxes? Plus, should you worry about President Biden’s proposal to increase them? Check This Out