As we approach “tax-season”, it’s important to understand different types of income and how they are taxed. Classic investments, like stocks, are one of several investments taxed by capital gains. Capital gains taxes can apply to any property that acquires value over time. These taxes are calculated by subtracting the cost of the investment from the final selling price of said investment. This final amount is reported as a capital gain. However, the final amount can be taxed at different rates depending on the investment type and total monetary gain.
Below we’re reviewing how capital gains taxes are determined and what methods you can use to reduce them.
Capital Gains Tax Rates
The total tax amount will depend on a variety of factors, though the IRS taxes most individuals at a rate of 15 percent.
Here are a few factors that determine capital gains tax rates:
- For married couples, a taxable income of less than $80,800 set your capital gains rate at zero percent.
- A rate of 15 percent is set if your income is between $80,800 and $501,600, but this range will change depending on your marriage filing status.
- Rates higher than 15-20 percent result from certain investment types and total income amounts.
It’s always a good idea to check with your tax advisor to understand how different investments are taxed.
Duration of the Investment
The amount of time you hold an investment can reduce the amount of taxes you ultimately pay. The IRS has established two investment types: short-term and long-term. Investment duration is calculated from the day of purchase to the day of sale – over a year is considered long-term, while short-term is under a year. Long-term capital gains are generally subject to normal capital gains rates, but short-term gains are usually taxed at your marginal tax bracket (frequently higher than 15%).
What Isn’t Affected by Capital Gains?
Certain types of property and accounts are not affected by capital gains taxes. If applicable, see if you can utilize these property and account types to maximize your investment.
There are two general property types unaffected by capital gains. The first is business property, including products. The second is anything you create as an individual. This could be a book you wrote or an invention you patent.
Alternatively, specific retirement and education accounts can help protect your investment from capital gains taxes, such as a Roth IRA.
Offsetting Capital Gains
Investments may not always pay off. Sometimes a market change results in your property reducing in value. This reduction is also calculated on your taxes and is calculated into your capital gains taxes. This can lower your taxable income range.
For example, if you receive $90,000 from selling one investment, you may be taxed in the 15 percent range. However, if you lost $15,000 on another investment, this would drop your total income from investments to $75,000, which could place you beneath the 15 percent tax range. These reductions and gains can only be combined if they are the same type of investment and sold in the same year.
Capital gains taxes can be postponed by using the income to invest in a similar property type. However, make sure to consult the IRS website or your tax professional before moving forward on any like-kind exchange, as the requirements and investment types have changed over the years.
Make sure you prepare to protect your investments from higher tax rates. And when selling an investment, or even a piece of property, make sure to consult a financial advisor or IRS representative to help determine how much you could be taxed.