The information in this article is up to date through tax year 2022 (taxes filed 2023).
What are capital gains and losses?
A “capital asset” describes everything you own for personal use (not business) or investment purposes. Stocks and bonds, land, your house and car, even your furniture are all examples of capital assets. If you sell your asset for more than you paid for it, the difference is called a capital gain. If you lose money on the sale, it is called a capital loss.
If you have capital gains and losses over the course of the year, you’ll need to determine your “net capital gain” when you file your taxes. This is very simply the difference between your gains and your losses. If your losses are greater than your gains, that difference, your net capital loss, is deductible up to $3,000, depending on your filing status.
What type of capital gains do I have?
There are two types of capital gains determined by the holding period: short-term or long-term. If you own a capital asset for less than a year (365 days) and then sell it for more than you paid for it, you have a short-term capital gain. If you held your asset for more than a year before selling it, you have a long-term capital gain.
What is a holding period?
The holding period determines if your capital gain or loss is considered short-term or long-term. It is the amount of time the asset is held in your possession prior to selling. If you own the property for less than a year (365 days) it is considered a short-term capital gain or loss. Long-term capital gains (or losses) are ones you own for more than one year prior to selling. When calculating the holding period, generally, you will not include the day of purchase. However, you will include the day of the sale. This timeframe is significant because short-term and long-term gains are taxed at different tax rates.
How are capital gains taxed?
Short-term capital gains are taxed at the same rate as your ordinary income.
Long-term gains, on the other hand, are not taxed as income. The tax rates on long-term capital gains are 0%, 15%, or 20%. The rate of taxation is determined by the income threshold. These are as follows:
- 0% for income up to $41,675 for single filers ($83,350 for joint filers)
- 15% for income between $41,676 and $459,750 ($83,351 to $517,200 for joint filers)
- 20% for income above $459,751 (above $517,201 for joint filers)
How can I protect my capital gains from tax?
1. Save for retirement – Contributing to a 401(k) or a Roth account can really be a huge tax advantage in the long run. Money invested in these types of savings plans is allowed to grow and be withdrawn tax-free.
2. Save for college – If you make contributions to a 529 savings plan, you do not have to pay tax on the earnings or withdrawals. Under the current laws of the Tax Cuts and Jobs Act, you can use the savings in your 529 to pay for private or public school tuition for grades K-12 as well as college.
3. Hold on for one year – The tax rates for short-term gains are quite a bit higher than the long-term rates. If you can wait to sell, use the time factor to your advantage.
You may also be interested in reading: Capital Gains on Sale of a Home
What is a capital loss?
When you sell an asset, the difference between the cost basis of the property and the amount it is sold for determines whether it is a capital gain or loss. A capital loss occurs when an asset is sold for less than the cost basis. The basis is typically the cost of the property you acquired. The cost includes the amount you pay in cash, debt obligations, other property, or services. The adjusted cost basis is the original cost of the property, plus or minus certain additions or deductions. Circumstances like if you received the property through gift or inheritance will impact how your cost basis is determined.
Capital losses will also be reported on Schedule D of Form 1040 and will offset your overall capital gains. However, there is a limitation on the amount of capital losses that can be claimed. Once your gains have been offset, excess losses up to $3,000 can be claimed on your return ($1,500 if you are married filing separately).