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Understanding Capital Gains Tax
What are Capital Gains?
Capital gains are profits realized from the sale of capital assets such as stocks, bonds, real estate, or other investments. The gain is calculated as the difference between the selling price and the original purchase price (cost basis), minus any selling expenses.
Short-term vs Long-term Capital Gains
Short-term Capital Gains
Assets held for one year or less are taxed at your ordinary income tax rate (10-37% depending on your income bracket). These rates are typically higher than long-term rates.
Long-term Capital Gains
Assets held for more than one year receive preferential tax rates: 0% for low-income taxpayers, 15% for most taxpayers, and 20% for high-income taxpayers.
US Federal Tax Rates (2024)
| Tax Rate | Short-term (Ordinary Income) | Long-term (Capital Gains) |
|---|---|---|
| 10% | Up to $11,000 | Up to $44,000 |
| 12% | $11,001 - $44,725 | $44,001 - $95,375 |
| 15% | $44,726 - $95,375 | $95,376 - $182,050 |
| 20% | Over $578,125 | Over $578,125 |
Capital Gains Tax Formula
Tax Amount = Capital Gain × Tax Rate
Net Proceeds = Sale Price - Tax Amount - Selling Expenses
Tax Planning Strategies
- Hold investments for more than one year to qualify for lower long-term rates
- Consider tax-loss harvesting to offset gains with losses
- Time sales to manage your annual income and tax bracket
- Utilize tax-advantaged accounts when possible
- Keep detailed records of all purchase and sale transactions
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Frequently Asked Questions
What is the difference between short-term and long-term capital gains?
Short-term capital gains apply to assets held for one year or less and are taxed at your ordinary income tax rate. Long-term capital gains apply to assets held for more than one year and receive preferential tax rates of 0%, 15%, or 20%.
How is cost basis calculated?
Cost basis is typically the original purchase price of an asset plus any commissions or fees paid. For inherited assets, the cost basis is usually the fair market value at the time of inheritance.
Do I have to pay capital gains tax if I reinvest the money?
Yes, capital gains tax is generally due when you sell an asset, regardless of whether you reinvest the proceeds. However, certain investments like 1031 exchanges or opportunity zones may offer tax deferral.
What about state capital gains tax?
Most states also tax capital gains, but rates and rules vary significantly. Some states have no income tax, while others tax capital gains at the same rate as ordinary income. Check your state's specific regulations.
Can I offset capital gains with capital losses?
Yes, you can offset capital gains with capital losses. If your losses exceed your gains, you can deduct up to $3,000 of net capital losses against ordinary income, with remaining losses carried forward to future years.
What records should I keep for capital gains tax?
Keep purchase and sale confirmations, broker statements, cost basis information, dividend reinvestment records, and any documentation of improvements or expenses that affect your cost basis. Records should be kept for at least 3 years.