When you sell an investment for a profit, the Internal Revenue Service wants its cut.
Capital gains are the profits you make when you sell a stock, mutual fund or other taxable asset.
Youll owe capital gains taxes if that investment increased in value while you owned it.
There are several legitimate ways to lower your capital gains tax liability, including investing in a retirement account.
What Is Capital Gains Tax?
Capital gains tax is a tax you pay on the profit made from selling an investment.
The tax isnt due until after you sell.
Probably not as good as youd like.
It always seems like an uphill battle to build (and keep) a decent amount in savings.
But what if your car breaks down, or you have a sudden medical bill?
Capital gain taxes are due the same tax year you sell an investment, typically the following calendar year.
What Is Short-Term Capital Gains Tax?
Short-term capital gains tax is a tax on the sale of capital assets owned for one year or less.
What Is Long-Term Capital Gains Tax?
Most people fall into the 15% long-term capital gains rate.
Long-term capital gains are levied on assets sold a year or more after purchase.
Short-term capital gains are taxed at ordinary income tax rates.
How Do Capital Gains Tax Work?
Most people pay no more than 15% on long-term capital gains taxes.
Thats usually more favorable than short-term capital gains tax rates, which follow your income tax bracket.
When Do You Pay Capital Gains Taxes?
You generally owe capital gains tax for the tax year you sell an investment.
Remember: Capital gains tax isnt due until after an investment is sold.
When you sell an investment, its called a realized gain or loss.
The transaction is complete and youve made your profit or taken your loss.
If you havent actually sold the capital asset, any investment profits or losses are called unrealized gains/losses.
Exceptions to Capital Gains Tax Rules
Not all assets receive the same capital gains tax treatment.
If youre selling collectibles or real estate, be aware of these rules.
High-income earners also pay a higher tax.
Owner-Occupied Real Estate
Capital gains taxes are also calculated differently for most homeowners.
Married couples filing jointly can exclude the first $500,000.
To qualify, you must not have excluded another home from capital gains within the last two years.
But you’ve got the option to still take a stab at crunch the numbers yourself.
First, separate your short-term gains and losses from your long-term gains and losses.
(Short-term losses can offset short-term gains.
Long-term losses can offset long-term gains.)
Youre taxed on the capital gain ($200), not the sale price ($700).
The difference between your capital gains and capital losses is called your net capital gain.
If your gains outnumber your losses, you experience a net capital loss.
This doesnt bode well for day trading, but investing long-term can help reduce your tax bill.
you’ve got the option to use capital losses to offset capital gains.
This strategy is called tax loss harvesting.
Many financial advisors offer this service.
Its also a feature of several robo-advisors, such asWealthfront.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.
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