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?
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.
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%. 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 $40,000 for single filers ($80,000 for joint filers)
15% income between $40,001 and $441,450 ($80,001 to $496,600 for joint filers)
20% for $441,451 and above ($496,601 and above 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 Money invested in these types of savings plans is allowed to grow and be withdrawn tax-free.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. 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.
The information in this article is up to date through tax year 2020 (taxes filed 2021).