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The above article is intended to provide generalized financial information designed to educate a broad segment of the public it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
Cash In After Retiring
As you approach retirement, consider waiting until you actually stop working to sell profitable assets. The capital gains tax bill might be reduced if your retirement income is lower. You may even be able to avoid having to pay capital gains tax at all.
In short, be mindful of the impact of taking the tax hit when working rather than after you’re retired. Realizing the gain earlier might serve to bump you out of a low- or no-pay bracket and cause you to incur a tax bill on the gains.
How To Report And Pay The Tax
Only individuals owing capital gains tax are required to file a capital gains tax return, along with a copy of their federal tax return for the same taxable year. The capital gains tax return is due at the same time as the individual’s federal income tax return is due. Individuals who receive a filing extension for their federal income tax return are entitled to the same filing extension for their capital gains tax return. However, a filing extension does not extend the due date for paying the capital gains tax due.
Penalties will apply to late returns. Additional penalties and interest will apply to late payments.
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How Does Capital Gains Tax Affect Inherited Property
Capital gains tax on estate property can kick in if the property is sold at a higher price than its purchase price. This means that the tax impacts the person who inherited property. If you are creating your Estate Plan and plan to pass property to your child for instance, then know that your child could be impacted by capital gains tax if they were to sell it. If you inherited a house from a relative, then you could pay capital gains tax if you sell the house.
If the property happens to be sold at a loss, then the person selling the property can claim a capital loss deduction. However, this is usually not the case as investments historically increase in value, especially real estate.
Luckily, the Internal Revenue Service applies a rule called stepped-up basis. This rule calculates how much capital gains tax is owed by using the property value at the time of inheritance, versus its original purchase price. This provides immense relief for tax payers in most cases. Lets use an example to help illustrate.
This is where we run into a problem. According to Zillow, the average home price in Burbank, CA today is over $1.1 million. Without the step-up basis, you would be facing a huge tax bill.
Can I Defer State Capital Gains Taxes With A 1031 Exchange
Some investors prefer to defer the payment of capital gains taxes when they sell an investment property. One way to accomplish this is by executing a 1031 exchange. In most cases, a 1031 exchange will allow the taxpayer to defer both state and federal capital gains taxes, plus depreciation recapture. However, keep in mind that the rules governing exchanges are strict, and investors must closely adhere to the timelines.
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Which Property Is My Main Home
If you use more than one home, you can nominate which will be tax-free for CGT purposes. It doesnt have to be the one where you live most of the time.
Generally, it makes sense to nominate the property thats you expect to make the largest gain when you come to sell it. You have two years from when you get a new home to make the nomination.
Capital Gains And Dividends Accrue Overwhelmingly To The Wealthy And Are Taxed At Preferential Rates
A capital gain is the profit from selling an asset such as a stock or other financial instrument, an interest in a business, or real estate. The gains from the sale of such assets held more than one year are considered long-term gains and taxed at special low rates. While ordinary income such as wages and salaries is taxed at rates ranging from 0 percent for low levels of income to 37 percent for the highest levels of income, long-term capital gains are taxed at 0 percent, 15 percent, and 20 percent. Most corporate dividends that are paid to shareholders are also taxed at these favorable rates. There is also a 3.8 percent Medicare tax on high-income taxpayers net investment income, including capital gains and dividends. The 3.8 percent net investment income tax was enacted in companion legislation to the Affordable Care Act in 2010 and essentially parallels the Medicare tax on wages.1
Figure 1
The vast majority of capital gains and dividends reported on tax returns are received by individuals at the very top of the income spectrum. According to the Tax Policy Center , the richest 1 percent of Americans reported an estimated 75 percent of all long-term capital gains in 2019, with the richest 0.1 percentpeople with annual incomes exceeding $3.8 millionbringing in more than half of all gains.2
Figure 2
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Which Assets Qualify For The Capital Gains Tax
Capital gains taxes can apply to any capital asset, which includes nearly everything you own for personal or investment purposes. Your home, furniture, vehicles, investment holdings, and other belongings are all capital assets. As a result, if you sell those assets for more than you bought them, you could be on the hook for capital gains taxes. However, the assets investors most often have to pay capital gains taxes on include investments like stocks, bonds, cryptocurrency, real estate, and more.
There are a few types of assets that are treated slightly differently for tax purposes. Perhaps one of the most important exceptions to the capital gains tax is your primary residence. Current tax law allows you to sell your home and exempt the first $250,000 of profit from the capital gains tax. In general, this exemption applies if youve lived in the home for at least two of the past five years, though its important to confirm eligibility requirements via the IRS site or with a tax advisor.
Other assets that have different tax treatment under the capital gains law include section 1202 small business stock, collectibles such as coins and art, and unrecaptured section 1250 gains from selling section 1250 property. Those assets are subject to a capital gains tax rate of 28%, 28%, and 25%, respectively.
How Much Is Capital Gains Tax On The Sale Of A Home
When selling your primary home, you can make up to $250,000 in profit or double that if you are married, and you wont owe anything for capital gains. The only time you will have to pay capital gains tax on a home sale is if you are over the limit.
Many sellers are surprised that this is true, especially if they live in their homes for years. This is because, before 1997, the only way you could avoid paying taxes on the profits from a home sale was to use it to purchase an even more expensive house within two years.
Taxpayers over 55 had other options. They could take a once-in-a-lifetime tax exemption of up to $125,000 in profits. This required Form 2119 to be filed too.
Thankfully, in 1997, the Taxpayers Relief Act was introduced, and millions of residential taxpayers had the burden lifted. The lifetime option was replaced with the current sale of home exclusion amounts. This change makes it easier for homeowners to sell their current residence if they want to.
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How Can You Minimize Capital Gains Taxes
There are several ways you can minimize the taxes you pay on capital gains:
How To Calculate Long
Most individuals figure their tax using software that automatically makes the computations. You can also use a capital gains calculator to get a rough idea. Several free calculators are available online. Still, if you want to crunch the numbers yourself, here’s the basic method for calculating capital gains tax:
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Capital Gains Taxes On Collectibles
If you realize long-term capital gains from the sale of collectibles, such as precious metals, coins or art, they are taxed at a maximum rate of 28%. Remember, short-term capital gains from collectible assets are still taxed as ordinary income. The IRS classifies collectible assets as:
- Works of art, rugs and antiques
- Musical instruments and historical objects
- Stamps and coins
- Alcoholic beverages
- Any metal or gem
The latter point is worth reiterating: The IRS considers precious metals to be collectibles. That means long-term capital gains from the sale of shares in any pass-through investing vehicle that invests in precious metals are generally taxed at the 28% rate.
What Is The Dividend Tax Rate
The tax rate on qualified dividends is 0%, 15% or 20%, depending on your taxable income and filing status. The tax rate on nonqualified dividends is the same as your regular income tax bracket. In both cases, people in higher tax brackets pay a higher dividend tax rate.
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How Do I Avoid The Capital Gains Tax On Real Estate
If you have owned and occupied your property for at least 2 of the last 5 years, you can avoid paying capital gains taxes on the first $250,000 for single-filers and $500,000 for married people filing jointly.
Visit the IRS website to review additional rules that may help you qualify for the capital gains tax exemption.
Offset Gains With Losses
One of the simplest ways to reduce your exposure to the capital gains tax is to offset the profits made from selling a home with losses that have been realized from another investment. While the Internal Revenue Service taxes profits made from investments, investors can deduct losses from their taxable income. Otherwise known as tax-loss harvesting, this particular strategy reduces exposure to taxes levied on gains. By accounting for both gains and losses, investors can reduce the capital gains they are taxed on.
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Some States Have Tax Preferences For Capital Gains
The federal government taxes income generated by wealth, such as capital gains, at lower rates than wages and salaries from work. The highest-income taxpayers pay 40.8 percent on income from work but only 23.8 percent on capital gains and stock dividends.
While most states tax income from investments and income from work at the same rate, nine states Arizona, Arkansas, Hawaii, Montana, New Mexico, North Dakota, South Carolina, Vermont, and Wisconsin tax all long-term capital gains less than ordinary income. These tax breaks take different forms. Typically, these states allow taxpayers to exclude some or all of their capital gains income from their taxable income, but others levy a lower rate than the state tax on ordinary income or provide a credit equal to a percentage of the taxpayers capital gains. In addition, a handful of states provide breaks only for capital gains on investments in in-state businesses, and a few states target preferences to investments in specific industries, like farming in Iowa and Wisconsin.
How Can Capital Losses Affect Your Taxes
As previously mentioned, different tax rates apply to short-term and long-term gains. However, if your investments end up losing money rather than generating gains, those losses can affect your taxes as well. However, in this case, you can use those losses to reduce your taxes. The IRS allows you to match up your gains and losses for any given year to determine your net capital gain or loss.
- If after fully reducing your gains with your losses and you end up with a net loss, you can use up to $3,000 of it per year to reduce your other taxable income.
- Any additional losses can be carried forward into future years to offset capital gains and up to $3,000 per year of ordinary income.
- Since you don’t generate capital gains or losses in a retirement account, you can’t use losses in IRAs or 401 plans to offset gains or your other income.
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What Is A Capital Gain
A capital gain happens when you sell or exchange a capital asset for a higher price than its basis. The basis is what you paid for the asset, plus commissions and the cost of improvements, minus depreciation. There is no capital gain until you sell an asset, but once youve sold an asset for a gain, youre required to claim it on your income taxes. Capital gains are not adjusted for inflation.
Heres how capital gains are calculated:
- Find your basis. Typically, this is what you paid for the asset, including commissions or fees.
- Find your realized amount. This will be what you sold the asset for, less any commissions or fees you paid.
- Subtract the basis from the realized amount. If your sale price was higher than your basis price, its a capital gain. If your sale price was less than your basis price, its considered a capital loss.
States Levy Taxes In Addition To The Federal Taxes
The rates for federal taxes on long-term capital gains range from zero to twenty percent, depending on income level and filing status. For example, a married couple filing jointly can earn up to $83,350 and not owe federal taxes on a realized capital gain. The rate is 15% for a couple with a taxable income of up to $517,200 and 20% for those with taxable income above that.
Nine states have no additional state capital gains tax. Some, like Texas and Florida, have no state income taxes either. Other states range from low tax states with capital gains rates around two percent up to high taxing California, which adds over 13 percent to the tab for capital gains. Aside from Texas and Florida, states with no capital gains tax are:
Some states with capital gains levies allow the deduction of federal charges from state income.
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What Are The Problems With The Way We Tax Capital Gains Now
Although taxation on realization provides advantages withrespect to liquidity and valuation, it also creates several problems. Theunderlying problem is that the current system does not tax a householdseconomic income, which is the sum of the households consumption and the changein its wealth during the year. By this standard, all capital gains that occurin the year in question should be includedwhether realized or unrealized.
Taxation on realization creates what is called a lock-ineffect. When the tax rate on capital gains is constant with respect to theholding period, investors are financially rewarded for deferring the sale ofthe asset for as long as possible. Under taxation upon realization, theeffective after-tax return rises with the length of the holding period, even ifthe pre-tax return and tax rates are constant.
For example, compare a stock producing a 10 percent annualreturn and a bond that produces 10 percentinterest each year. Assume that both the capital gains tax rate and the ordinaryincome tax rate are 30 percent. After one year, the bond would generate a 7percent after-tax return. Similarly, if the stock were sold and the capitalgains tax were paid, the stock would generate the same after-tax return of 7percent.