When you sell a capital asset like a stock, bond, cryptocurrency or investments you own, the difference between the amount you sell it for and what you paid for it (cost basis) is classified as a capital gain or a capital loss.
Capital gains and losses are further classified as long-term or short-term, depending on how long you held the investment before you sold it or “realized” the gain.
If you have held the asset more than one year, your capital gain or loss is classified as long-term. If you held the asset for one year or less, your capital gain or loss is considered short-term.
Because tax filers have several asset types that move in different directions capital gains can offset capital losses (or vice-versa), so your net capital gain/loss is the key figure to use in your tax planning
Based on the duration of asset ownership, filing status and the tax filers personal tax rate, you can calculate your capital gains tax rate.
There are also ways to benefit from Capital Losses, which happens when you sell assets for a loss, that reduce your overall taxable income. See sections below and what to be aware when it comes to capital tax loss harvesting.
How are short or long term capital gains taxed?
Short-term capital gains are taxed like ordinary income at federal tax rates. For example if Julia bought shares in Apple (AAPL) in February and sold them in November of the same year, her gain or loss on the investment will be classified as short-term.
Long-term capital gains (assets held for more than one year) are a little more complicated and are based on the taxpayers taxable income (AGI) and filing status. The capital gains tax is 0% for taxpayers in the 10% and 15% federal tax brackets and 15% for taxpayers in the 25%, 28%, 33%, and 35% federal tax brackets. Those in the 39.6% federal tax bracket rose are taxed at 20%.
Based on the latest federal tax rate brackets and income (AGI) thresholds, you can see the applicable long term capital gains tax (LCGT) rates and income thresholds in the tables below for 2022 and 2023
|Seller's Federal IRS Tax Rate||10%||15%||25%||28%||33%||35%||39.6%|
|Short Term CGT Rate||10%||15%||25%||28%||33%||35%||39.6%|
|Long Term CGT Rate||0%||0%||15%||15%||15%||15%||20%|
2022 Long Term Capital Gain Tax (LGCT) Rates based on Taxable Income
|2022 Filing Status||0% LCGT Rate||15% LCGT Rate||20% LCGT Rate|
|Single||$0 to $41,675||$41,676 to $459,750||Above $459,751|
|Married, filing jointly||$0 to $83,350||$83,351 to $517,200||Above $517,201|
|Married, filing separately||$0 to $41,675||$41,676 to $258,600||Above $258,601|
|Head of household||$0 to $55,800||$55,801 to $488,500||Above $488,501|
2023 Long Term Capital Gain Tax Rates based on Taxable Income
The 2023 LGCT income thresholds (for 2024 filings) rose significantly from 2022 levels due to the high COLA.
|2023 Filing Status||0% LCGT Rate||15% LCGT Rate||20% LCGT Rate|
|Single||$0 to $44,625||$44,626 to $492,300||$492,301 or more|
|Married, filing jointly||$0 to $89,250||$89,251 to $553,850||$553,851 or more|
|Married, filing separately||$0 to $44,625||$44,626 to $276,900||$276,901 or more|
|Head of household||$0 to $59,750||$59,751 to $523,050||$523,051 or more|
|Estates and Trusts||$0 to $3,000||$3,001 to $14,650||$14,651 or more|
How to read the above tables:
If Jim had taxable earnings of $38,000 as a single filer, any long term capital gains he had would not be subject to taxes since he was at the 0% CGT.
Sarah and Jim, earned over $600,000 and were filing a joint return. In this situation, they would be subject to the 20% long term capital gains rate given their level of income.
Capital Loss Deduction (Tax Loss Harvesting)
If your capital losses are more than your capital gains, you can claim a capital loss deduction in your 1040 tax filing.
Your allowable deduction is $3,000 ($1,500 if you are married and filing separately) and can be claimed against your ordinary taxable income if you don’t have sufficient gains to offset this against.
Capital loss deductions are very useful for tax planning and in years when markets are bad, which allows you to lower your taxable income. You can also carry forward capital losses for future years, until you exhaust the entire amount against capital gains or ordinary income.
Note however that when you carry over a loss, it remains long term or short term (use this first).
If you use capital losses to reduce your taxable income as part of tax planning, be aware of the “wash rule” which will penalize if you acquire similar or substantially identical stock or securities before a 30 day waiting period.
You can see my tax loss harvesting strategy here, which compromises or three steps to figure your realized gains, sell relevant assets and do a final reconciliation before year end.
There are various exceptions and special provisions when it comes to the treatment of capital gains or losses and you should consult IRS Publications. Some highlights are provided below.
Capital Gains Treatment of Dividends and ETF/Fund distributions
One thing which surprises tax payers at year-end is getting a capital gain tax hit when they see their 1099 investment forms from their mutual fund provider.
This is because capital gain distributions (also called capital gain dividends) paid to you by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs) are also subject to the above CGT rules.
Dividends on the other hand are paid out of the earnings and profits of a corporation – are generally ordinary income to you. This means they are not capital gains, and so do not qualify for the lower tax capital gain rates.
3.8% Net Investment Income Tax (NIIT)
As part of recent tax reform packages, an additional 3.8% investment tax for single or head of household taxpayers who make (MAGI) more than $200,000 per year and married taxpayers who file jointly and earn more than $250,000.
While there is a lot to consider when it comes to capital gains and investment taxes, most good tax software packages, will calculate your relevant tax obligations. However for tax planning or complex investment situations, it may be worth working an accountant to ensure you legally minimize your tax liability.
Investment Cost Basis
As part of your capital tax loss harvesting strategy, it is also important to consider how the cost basis for your investments is calculated. You can use the average-cost method or actual-cost method.
The cost basis is all-in price you paid for a security, which includes any brokerage fees or commissions. If you have acquired multiple lots of the same security through purchases or dividend reinvestments, the cost basis can be calculated using either the average-cost method, which averages the cost of all purchases, or the actual-cost method, which tracks the specific cost of each lot of shares.
For tax-loss harvesting, the actual-cost method may be more beneficial because it allows you to sell specific, higher-cost shares, which can increase the amount of the realized loss.