The sale of an asset can be significantly affected by capital gains taxes, which depend on various factors, including the duration of asset ownership, the asset category, the taxpayer’s income, and other relevant details. Prior to selling an asset, investors must conduct proper research to fully comprehend their tax obligations.
Capital gains tax rates at the federal level fluctuate based on the taxpayer’s filing status and income. Typically, state capital gains taxes are also applicable, which can escalate the overall capital gains tax liability. Familiarizing oneself with state-specific capital gains tax rates can aid in assessing the tax responsibility for the year.
What Is Capital Gains Tax?
Capital gains tax pertains to the tax imposed on the profit obtained by a taxpayer after selling a capital asset, like real estate property, stocks, bonds, and cryptocurrencies. If the sale of an asset generates revenue surpassing the adjusted basis, the taxpayer incurs a capital gain. Conversely, capital losses occur when the asset is sold for less than its adjusted basis.
Long-term and short-term capital gains and losses are categorized by the Internal Revenue Service (IRS). A long-term capital gain arises when an asset is held for over a year, while any capital gains on an asset held for one year or less are short-term. Compared to long-term gains, short-term capital gains have a higher tax rate.
2023 Tax Rates for Long-Term Capital Gains
The federal capital gains tax rates vary between 0%, 15%, and 20%, depending on the taxpayer’s annual taxable income and filing status. Below are the 2023 tax rates for long-term capital gains, as stated in the IRS Revenue Procedure 2022-38:
Filing as single: Individuals with an income of up to $44,625 fall under the 0% tax rate category. Incomes ranging from $44,626 to $492,300 are subject to the 15% tax rate, while those exceeding $492,300 fall under the 20% tax rate category.
.Married and filing joint returns: Individuals with an income of up to $89,250 are subject to the 0% tax rate, while those with incomes ranging from $89,251 to $553,850 are taxed at 15%. Incomes surpassing $553,850 are taxed at a rate of 20%.
Married and filing separate returns: Individuals with an income of up to $44,625 are taxed at a 0% rate, while those with incomes ranging from $44,626 to $276,900 are taxed at 15%. For incomes exceeding $276,900, the tax rate increases to 20%.
Head of household: Individuals with an income of up to $59,750 are subject to a 0% tax rate, while those earning between $59,751 and $523,050 are taxed at a rate of 15%. For incomes exceeding $523,050, the tax rate increases to 20%.
Special Capital Gains Rates and Exceptions
The IRS treats certain asset classes differently from the regular long-term capital gains treatment. As an investor, it is crucial to be aware of these special rates and exemptions that could apply to your investments.
Collectibles are high-value items like artwork, antiques, stamp collections, or coins. Irrespective of the owner’s income, the IRS levies a tax of 28% on capital gains resulting from the sale of collectibles.
Investment Real Estate
Real estate investors have the benefit of deducting depreciation on their investment properties from their income taxes. However, they must reduce the property’s basis by the amount of depreciation, whether or not they took the deductions. As depreciation deductions lower the property’s purchase price, investors taking the deductions could potentially incur higher taxable capital gains on selling the property.
Owner-Occupied Real Estate
Taxpayers may be eligible for a capital gains exclusion on the sale of their primary residence. Individuals can exclude up to $250,000 in capital gains from the sale of their home, while married couples filing jointly can exclude up to $500,000. Meeting the ownership and use requirements is necessary to qualify for this exclusion, which can considerably reduce the homeowner’s capital gains tax liability.
Net Investment Income Tax
Investors with a net investment income above applicable thresholds may face an additional tax known as the Net Investment Income Tax (NIIT). For individual investors, the NIIT is 3.8% on the lesser of:
- The individual’s total net investment income.
- Any amount exceeding the individual’s modified adjusted gross income based on specific thresholds.
Calculating Your Capital Gains
As tax laws can be intricate, many taxpayers rely on tax software or seek the assistance of tax professionals who possess an understanding of the intricacies of the rules to determine their capital gains tax liability. Nonetheless, a capital gains tax calculator can also assist in determining the total tax required to be paid on the sale of an asset.
Taking the following steps can help you calculate your capital gains for the year:
- Determine your basis for all assets sold: The basis of an asset refers to the initial cost of purchasing the asset along with any additional expenses incurred during the transaction such as fees and commissions.
- Calculate realized capital gains: To calculate your capital gains, deduct any transaction costs from the sale price of your asset and then subtract your basis from the remaining amount.
- Determine short-term and long-term gains and losses: To accurately calculate your taxable capital gains, it is necessary to subtract your capital losses from your capital gains. This process can be simplified by separating your short-term capital gains and losses from your long-term ones.
- Figure net gains or losses: To determine your taxable capital gains, you should reconcile the appropriate numbers to find the total short-term gain, short-term loss, long-term gain, and long-term loss. Next, calculate your net short-term gain or loss and net long-term gain or loss.
Capital Gains Tax Strategies
There are various strategies that investors can utilize to lower their capital gains tax liability. Although these strategies are commonly employed, it’s crucial to discuss your options with a tax professional to determine which strategies align with your specific tax circumstances.
1. Leverage Capital Losses
If a taxpayer experiences a net capital loss for the year, where capital losses exceed capital gains, they can claim up to $3,000 of the loss against their income. In cases where the loss exceeds $3,000, they may carry it forward to future years and use it to offset their capital gains and reduce their tax liability.
2. Invest in Tax-Advantaged Retirement Accounts
Retirement accounts such as 401(k)s and traditional IRAs provide the benefit of tax-free contributions and tax-deferred growth, which means they are not subject to capital gains tax. However, taxes must be paid on these investments upon withdrawal. On the other hand, contributions made to Roth IRAs are taxed, but qualified distributions from these accounts are tax-free.
3. Pay Close Attention to Your Holding Period
To benefit from the more favorable long-term capital gains tax rates, an asset must be held for more than one year before being sold. It’s crucial to keep track of the days elapsed since acquiring an asset to avoid paying higher short-term capital gains rates.
4. Sell Assets After Retirement
Even though there is no specific capital gains exemption for older adults, delaying the sale of certain assets until after retirement could potentially lower the amount of taxes owed. This is because many retirees have lower incomes than when they were employed, placing them in a lower tax bracket and resulting in a lower tax rate.
5. Perform a 1031 Exchange
A technique to decrease your capital gains tax liability is to execute a 1031 exchange. This approach allows real estate investors to sell one investment property and utilize the earnings to acquire another property while postponing capital gains taxes. The replacement property must have an equal or higher value than the relinquished property. Investors can continue to execute 1031 exchanges to delay capital gains taxes indefinitely.
Capital Gains Tax Rates by State
Selling an investment can trigger state capital gains tax in addition to federal capital gains tax. The amount of state capital gains tax varies depending on the state in which you reside. Different states have different rules and regulations regarding capital gains. Consulting with a tax professional can help you navigate the specifics of your situation..
Some states do not impose capital gains tax. These states generally do not have a conventional income tax, but they may levy taxes on investment dividends and interest, based on their regulations:
- New Hampshire
- South Dakota
Here is the long-term capital gains tax by state:
- Alabama: 5.00%
- Alaska: 0.00%
- Arizona: 4.50%
- Arkansas: 5.50%
- California: 13.30%
- Colorado: 4.55%
- Connecticut: 6.99%
- Delaware: 6.60%
- Florida: 0.00%
- Georgia: 5.75%
- Hawaii: 7.25%
- Idaho: 6.93%
- Illinois: 4.95%
- Indiana: 3.23%
- Iowa: 8.53%
- Kansas: 5.70%
- Kentucky: 5.00%
- Louisiana: 4.25%
- Maine: 7.15%
- Maryland: 5.75%
- Massachusetts: 5.00%
- Michigan: 4.25%
- Minnesota: 9.85%
- Mississippi: 5.00%
- Missouri: 5.40%
- Montana: 6.90%
- Nebraska: 6.84%
- Nevada: 0.00%
- New Hampshire: 0.00%
- New Jersey: 10.75%
- New Mexico: 5.90%
- New York: 8.82%
- North Carolina: 4.99%
- North Dakota: 2.90%
- Ohio: 4.80%
- Oklahoma: 4.75%
- Oregon: 9.90%
- Pennsylvania: 3.07%
- Rhode Island: 5.99%
- South Carolina: 7.00%
- South Dakota: 0.00%
- Tennessee: 0.00%
- Texas: 0.00%
- Utah: 4.95%
- Vermont: 8.75%
- Virginia: 5.75%
- Washington: 7.00%
- West Virginia: 6.50%
- Wisconsin: 7.65%
- Wyoming: 0.00%
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