Capital Gains Taxes: Know the Basics When You Sell a House, a Stock Portfolio, or a Beanie BabyPublished:
Yes, that Beanie Baby can lead to a bear of a tax bill.
Minnie Arlowe felt so proud, prouder than she’d ever felt, when she finally sold the hyper, mega-ultra rare original-season, first-edition, never-been-out-of-the-box Beanie Baby that she saved since she was 11 and daydreaming of swimming in a sea of paper dollars she’d earn by selling this single Beanie Baby. The check for a quadrillion dollars was still settling into her hand when she heard a knock.
“I’m with the IRS. Congratulations on selling a Mr. Flufflerumpkins, did I say that right? I’m here to talk to you about capital gains tax.”
Minnie wished she had a stuffed animal to hold.
Aside from income taxes, the Internal Revenue Service also collects taxes based on the profits from selling assets, such as a house, company stock, high-value collectibles, or any other thing you can sell for more than you paid for.
That’s called capital gains taxes.
Anytime you sell assets for profit, you’ll have a taxable capital gain. As in, you gained more money in the sale than how much you paid for it. Assets could be any personal property or intangible object, from NFTs and cryptocurrency to small stuffed animals from the 1990s that still sell for five figures at auction.
Understanding how much you might owe in taxes if you sell any mutual funds or real estate can seem complicated. Consider using a tax calculator to understand how real estate sales, art collection hobby, and gains from stock sales can affect your taxable income.
The Basics of Capital Gains Taxes
Capital gains taxes are based on these basic principles:
- You only pay a tax on profits, not the whole sale price of whatever asset you just sold.
- Your investment profit is the difference between how much you paid for the asset to acquire it (your cost basis) and whatever the final selling price was when you sold it.
- Most expenses associated with buying that asset at first become part of your cost basis.
- 4. Your tax rate on capital gains is based on how many years you owned the asset before selling it. Was it just one year or less? That’s short term. You have to hold an asset for longer than a year for the IRS to consider it a long-term capital gain or loss.
- Your tax bracket and the amount of time that you hold the asset will determine how much you pay in capital gains tax. Long-term is better.
If you bought a Beanie Baby for $10 in 1990 and sold it 30 years later for $50,000, that’s a handsome profit. The entire taxable gain is $49,990, the sale price minus the $10 you paid for it. Also, 30 years is a long holding period, making your profit a long-term gain and qualifying for a lower tax rate than what you’d pay at ordinary income tax rates. Your regular income level might put you at the 35% income tax bracket, but that Beanie Baby gets taxed at 28% because it’s a collectible, like art, rare coins, or comic books. That means you owe 28% of your $49,990 to the IRS, a total tax liability of $13,997.20. (That might seem like a heavy tax liability, but remember, you only paid $10 to earn $35,992.80 from a stuffed bear. You’re having a good day.)
Long-term Capital Gains Taxes: Why Hold a Capital Asset to Make It a “Long-term” Capital Gain?
Long-term investments can soak up your assets, but the tax advantages are undeniable. In short, the long-term capital gains tax offers the most favorable capital gain rates. Instead of getting taxed on your federal income tax rate, your profits would get taxed based on where your income falls in these three tax brackets:
- 0% if you have an income at or below $44,625 (or $89,250 if you’re married filing jointly with income.) Low-income individuals, classified as those in the two lowest tax brackets, are not required to pay capital gains tax.
- 15% if you’re single and your income is between $44,626 and $492,300 or if you’re married filing jointly and your income is between $89,251 and $553,850.)
- 20%: if your single-filer income is more than $492,300 or if you’re filing a joint return and your combined income is more $553,850.
For head of household filers, you would pay the 15% rate if your income is between $55,800 and $488,500
In special cases, long-term capital gains tax rates may go higher than 20%. Beanie Babies, precious metals and art have a long-term capital gain rate of 28%. If you sell qualified small business stock, the long-term gain gets taxed at 28% at the most. Also, certain types of rental property get taxed at 25% if you sell them. On top of High-income earners at the highest may also have to pay an additional 23.8% surtax.
Homes are one of the biggest assets most anyone ever owns. However, does that mean you have to pay capital gains taxes whenever you sell your home? Especially in a regular real estate market when home prices steadily rise, a tax liability seems like an unavoidable problem, even if you can write off expenses to closing costs against any gains. That’s why the IRS set an exemption on homes; if you lived in your home in a two-year period out of the last five-year period, then you don’t have to pay any gains taxes on the first $250,000 if you’re single (twice that if you’re married.)
Short-Term Capital Gains Tax Rates: The Same as Your Regular Income Tax Rates
Whatever your own tax bracket is, that’s what your short-term capital gains tax rate will be. If you bought and sold some assets in the same year, the IRS essentially considers that ordinary income and doesn’t give the same tax advantages for holding onto the asset. Short-term gains are essentially treated as income for tax purposes. If you’re a day trader or flipping real property, the rules for capital gains tax apply your federal tax bracket to those profits.As a consequence, short-term capital gains rates can be as high as 35% depending on your income bracket.
No matter how long you have owned an asset, when you sell it for a profit you are making money and have some kind of capital gains exposure. What about when you sell capital assets for less than your original purchase price?
Those are capital losses.
Offsetting Gains with Losses: The Silver Lining of Short- and Long-term Losses
Did you sell your asset for more than your acquisition cost? Congrats, that’s a capital gain. If you sell it for less than what you bought it for, well, that’s a capital loss.
Even educated investors lose from time to time.
However, there is a silver lining: You can deduct the capital losses on your tax return to reduce your taxable income. A short-term loss offsets your short-term gains; long-term capital losses offset long-term gains. All capital gains and deductible capital losses must be reported to the IRS using Tax Form 1040, Schedule D (Capital Gains and Losses). The information reported on Schedule D must also be recorded on Line 13 of Tax Form 1040. Any excess capital loss isn’t gone if you don’t claim them on the tax year they occurred; you can carry it forward. Building up additional loss might not be a strategy you want to explore, but it’s one way to protect your profitable investments when you make a sale.
Any excess capital loss can only go so far: Net capital losses can be claimed for a tax deduction. If you have more capital losses than gains, you may be able to deduct the difference on your tax return to reduce your taxable income. However, you can only put $3,000 in your investment losses to lower your taxable income from your day job each year.
Capital loss rules can be complex, so we recommend partnering with a trusted tax advisor and professional financial advisor to plan your short-term losses when your mutual funds start yielding what you hoped. You may be able to keep those capital loss tax deductions going and offset your taxes on capital gains when you hit it big with Beanie Babies.
“No, Minnie, losing cuddle time with Mr. Frufflerumpkin isn’t considered a capital loss, I’m afraid. Now, do you have a receipt from when you bought Mr. Fr– I’m sorry, I’m not saying that name again.”
Tax Deduction and Loss Carryover Limits
Capital losses can be an unpleasant reality for investors. However, there is a silver lining to these losses in the form of tax deductions and loss carryover limits.
When you experience a capital loss, you can use it to offset any capital gains you may have, potentially reducing your overall tax liability. If your capital losses exceed your capital gains, you are permitted to deduct the excess loss from your ordinary income up to a certain limit.
For individuals, this deduction limit is $3,000, or $1,500 if you are married filing separately. Any remaining losses can be carried forward to future years and used to offset future capital gains or deducted from ordinary income in those years.
It’s important to be aware of the rules and limitations associated with capital losses. The amount of excess loss you can claim is determined by subtracting your total capital gains from your total capital losses. Additionally, if your losses exceed the deduction limit, you can carry them forward to future years, but there are rules on how much you can offset each year.
To make the most of your capital losses, it’s essential to keep detailed records of all your transactions and consult with a tax advisor to ensure compliance with tax laws. By understanding the rules surrounding tax deductions and loss carryover limits, you can optimize your tax strategy and minimize your tax liability.
Do You Owe Capital Gains Taxes When the Sale Is Final?
When the sale of an investment is final, individuals may owe capital gains taxes depending on the specific circumstances of the transaction. Capital gains taxes are typically owed in the year the gain is realized, and the tax rate applied depends on the holding period of the investment. The sale of these assets may trigger a capital gain or a capital loss, depending on the difference between the purchase price (cost basis) and the selling price.
It’s important to consult with a tax advisor or use tax software to accurately calculate and report your capital gains taxes. They can help you navigate the rules and determine your tax liability based on your specific situation. Understanding the tax implications of your investment transactions can help you effectively manage your tax obligations and potentially maximize your after-tax returns.
What Is the Net Investment Income Tax? How Do You Know You Owe NIIT?
The Net Investment Income Tax (NIIT) is a tax that applies to individuals and estates/trusts with certain levels of income from investments. It was introduced as part of the Affordable Care Act to help fund Medicare. The NIIT is calculated based on the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds certain thresholds.
For individuals, the thresholds are $200,000 for single filers and married taxpayers filing separately, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. For estates and trusts, the threshold is $12,500.
The tax rates for the NIIT are 3.8% for individuals and 3.8% for estates/trusts. It’s important to note that the NIIT only applies to U.S. citizens and resident aliens.
To determine if you owe the NIIT, you need to calculate your net investment income and compare it to the threshold that applies to your tax filing status. Net investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from businesses involved in trading financial instruments or commodities.
Calculating your net investment income can be complex, so it’s best to consult with a tax advisor or use tax software. They can help you accurately determine if you owe the NIIT and assist you in filing your tax return properly.
Minnie’s grown wiser, after carving out the huge chunk of her soul that she’d hoarded up so long in a shoebox above the kitchen cabinets and selling it for oodles and oodles of money. Minnie got smarter, too. She’ll diversify her investments. She’ll start a business. She’ll keep receipts.
Her collection of Pokemon cards will learn from the mistakes of Mr. Frufflerumpkins.