The capital gains tax rate may not seem like much to worry about with the Dow Jones Industrial (.DJI) down 9 percent within the last year and the S&P 500 (.SPX) down nearly 7 percent during the same span.
However, if you sold property or came into some money this year, you may be on the hook for a different capital gains tax rate entirely.
Aside from what you've socked away in tax-deferred retirement plans including 401(k)s and individual retirement accounts (IRA), the Internal Revenue Service will always want a piece of your newfound wealth. Those windfalls are considered capital gains, and what you pay depends on how long you've held onto those assets.
Long-term vs. short-term capital gains taxes
Long-term capital gains are those you earn on assets you've held for more than a year. The current capital gains tax rates under the new 2018 tax law are zero, 15 percent and 20 percent, depending on your income. However, that rate doesn't apply to all assets. Here's the difference:
- Short-term capital gains tax: This is commonly applied to profits from selling an asset you've held for less than a year. Short-term capital gains taxes are pegged to your federal tax brackets, so you'll pay them at the same rate you'd pay your ordinary taxes.
- Long-term capital gains tax: This is applied to assets held for more than a year. Those are the zero, 15 percent and 20 percent rates mentioned earlier, and they're typically much lower than the ordinary income tax rate.
- Property sale tax: Home sales are a very specific form of capital gains, and are governed by their own set of rules.
What will the capital gains tax rate be in 2019?
The current capital gains tax rates under the new 2018 tax law are zero, 15 percent and 20 percent, depending on your income. The 2018 capital gains tax rate is holding steady through 2019, but the income required for each rate has changed.
For example, a single person won't pay any capital gains tax if their total taxable income is $39,375 or below. However, they'll pay 15 percent on those capital gains if their income is $39,376 to $434,550. Above that level, the rate jumps to 20 percent. Meanwhile, if those capital gains come from investments that don't require any work from the taxpayer – real estate rentals, royalties, partnerships – they may be subject to the net investment income tax (NIIT) of 3.8 percent if income is above certain amounts.
Meanwhile, for short-term capital gains on assets you buy and sell within a year, the current tax brackets for income taxes apply. The 2019 tax brackets are still 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. Unlike the long-term capital gains tax rate, the standard income tax rates are applied to short-term capital gains regardless of where taxpayers fall on the spectrum.
In other words, there is no zero-percent rate or 20-percent ceiling for short-term capital gains taxes.
How capital gains taxes work
If you buy $5,000 worth of stock in May and sell it in December for $5,500, you've made short-term capital gains of $500. If you make $38,701 to $82,500 a year, you're in the 22-percent bracket and have to give the IRS $110 of your $500 capital gains. That leaves you with $390.
If you, instead, hold onto it until the following December, at which point it has earned $700, it's a long-term capital gain. That same income puts you in the 15 percent bracket for that gain. Instead of paying $110, you'll pay $105 and see $595 worth of profit instead.
What counts as a capital gain?
If you sell an asset for more than you paid for it, that's a capital gain.
Much of what you own will experience depreciation over time, so most of your possessions will never be considered capital gains. However, if you sell artwork, a vintage car, a boat, or jewelry for more than you paid for it, that's considered a capital gain.
Meanwhile, if you're paid dividends from stocks that aren't in retirement accounts, those are subject to capital gains as well. You or your financial planner can reinvest gains to get around your tax bill, especially if you balance out your winners with some losers.
What is the capital gains tax on property sales?
Again, if you make a profit on the sale of any asset, it's considered a capital gain. With real estate and property, however, there are different rules for avoiding a capital gains tax hit.
For profits on real estate or property to be considered long-term capital gains, the IRS says you have to own the home and live in it for two of the five years leading up to the sale. You can exempt up to $250,000 in profits from capital gains taxes if you sold the house as an individual, or up to $500,000 in profits if you sold it as a married couple filing jointly.
As long as you haven't claimed a similar exemption on another property sale within the last two years, you should qualify for a capital gains exemption. If you're just flipping a home for a profit, however, you could be subjected to a steep short-term capital gains tax if you buy and sell a house within a year or less.
What if I lose money on investments?
Both long term capital gains taxes and short term capital gains taxes are applied to your net investment income. The IRS looks at the total of your gain when calculating tax, which means your losses can offset some of the gains and soften the hit a bit.
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