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?
If you own a capital asset for less than a year 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.
How are capital gains taxed?
Short-term capital gains are taxed at the same rate as your ordinary income. Note that the new tax laws changed the income tax bracket structure, which is most likely affecting how your income – and your short-term capital gains – are taxed. Learn more about the new income tax brackets here.
Unlike short-term capital gains, long-term gains are not taxed as income. The tax rates on long-term capital gains are 0%, 15%, or 20%. The Tax Cuts and Jobs Act did not change the rates, but the way the rates are applied is different. Prior to 2018, the rate your capital gains and qualified dividends were taxed at was based on the income tax bracket you were in. With the TCJA, the rate of taxation is now determined by income threshold. These are as follows:
0% for income up to $38,600 for single filers ($77,200 for joint filers)
15% income between $38,601 and $425,800 ($77201 to $479,000 for joint)
20% for $425,801 and above ($479,001)
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 Money invested in these types of savings plans is allowed to grow and be withdrawn tax-free.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. Read more about other tax law changes specifically affecting parents with dependents here.
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.
4.) Don’t include your home sale – You may be able to exclude up to $250,000 in gains ($500,000 if filing jointly) if you sold your home in the current tax year. To qualify, it must have been your primary residence for at least two of the five years leading up to the sale, and you must not have sold or claimed an exclusion for gains on another home sale within two years of this sale.
This article is up to date and accounts for tax law changes for tax year 2018 (tax returns filed in 2019). Learn more about tax reform enacted under the Tax Cuts and Jobs Act here.