Capital Gains Tax: Do I Have to Pay It?

The capital gains tax applies when you sell an asset for a profit. Understanding the tax rates, exceptions, and strategies to minimize your liability is crucial. Let’s explore how these taxes work and how you can reduce them.

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February 25, 2023

Tax Rates on Capital Gains

The tax rate depends on how long you held the asset before selling.

Short-Term Investments: If you held the asset for one year or less, the tax rate matches your federal income tax bracket (e.g., 10%, 12%, 22%).
Long-Term Investments: For assets held for more than a year, the tax rate is lower: 0%, 15%, or 20%, based on your taxable income and filing status.

Exceptions to Capital Gains Tax Rates

Certain assets have unique rules for the capital gains tax:

Collectibles: Items like coins, antiques, and art have a maximum long-term tax rate of 28%. Short-term collectible gains are taxed at your federal income tax bracket.
Section 1202 Qualified Small Business Stock: Taxed at a maximum rate of 28%.
Unrecaptured Section 1250 gain from selling depreciable property (commercial buildings, rental properties): Taxed at a maximum rate of 25%.

What If I Have a Loss?

Losses can help offset gains and reduce your taxable income.

Deductible Losses: You can deduct up to $3,000 of net capital losses ($1,500 for married filing separately) against ordinary income, carrying forward the rest to future years.
How losses are deducted: Short-term losses are deducted first against short-term gains, while long-term losses offset long-term gains. If net losses remain after this, they can be used to offset gains of the other type, maximizing your tax savings.

Examples:

If you have $7,000 in losses and $2,000 in gains, you have an excess loss of $5,000. You can offset $3,000 of ordinary income in the current year and carry forward $2,000.
If you have $7,000 of short-term losses and $6,000 of short-term gain, the remaining $1,000 short-term loss can be deducted against your net long-term gain if you have one.

Important: Losses from personal property, such as your car or home, do not qualify for deductions.

How Can I Minimize Taxes on Capital Gains?

Although paying taxes is often unavoidable, there are ways to lower your liability:

Hold Assets for the Long Term: Long-term tax rates are significantly lower than short-term rates.
Contribute to Retirement Accounts: Use tax-advantaged accounts like 401(k)s or IRAs to shield gains from taxes until withdrawal.
Live in Your Home for Two Years: By meeting this requirement, you can exclude up to $250,000 of gains (or $500,000 for married filers) when selling your primary residence. However, this exclusion cannot apply if you’ve already excluded gains from another sale in the past two years.
Like-kind Exchange (1031 Exchange): Like-kind exchange allows investors to defer paying capital gains taxes when they sell investment or business property and reinvest the proceeds into a similar type of property. Explore how 1031 Exchange help investors defer taxes.

Take Control of Your Tax Liability

The capital gains tax doesn’t have to catch you off guard. By learning about the tax rates, leveraging exemptions, and implementing strategic planning, you can minimize your tax burden while staying compliant. At DuPage Tax Solutions, we specialize in helping clients optimize their tax strategies to keep more of what they earn. Contact us today for expert guidance and a free consultation tailored to your needs.

References

Topic No. 409 Capital Gains and Losses | Internal Revenue Service. https://www.irs.gov/taxtopics/tc409