Capital gains can be a tricky thing to understand. One of the main questions is, how are capital gains taxed? This blog explains how capital gains will affect individual tax returns.
What is capital gain? A capital gain occurs when anything of value is purchased for one price and then sold later for more. This could happen when you buy a house, baseball card, or stocks. Anytime you realize a profit, the government wants their cut. This is capital gains tax. It is important to understand how these gains work so you can keep their cut as small as possible.
What is the difference between a short-term gain and a long-term gain? If you purchase property, stocks, or almost anything of value a clock starts ticking. If you keep the item purchased for over a year, then sell, generally, that transaction is considered long-term. If you sell the item within a year, then the transaction is classified as short-term.
Short-term could cost more than long-term. It is important to distinguish between short-term and long-term capital gains. Short-term capital gains are calculated as ordinary income. This means that short-term capital gains are taxed the same as if they are wages paid from a company.
Long-term capital gains are calculated a little more complexly. Long-term capital gains are taxed in tiers like ordinary income, but typically at less aggressive rates than income. Depending on your situation you could potentially owe NO TAX on a long-term gain, as opposed to the high tax rates on a short-term gain.
Capital Gains Tax Rates for 2021
Capital Gains Tax Rate | Single Filers | Married Filing Separate | Head Of House | Married Filing jointly |
0% | $0 to $40,400 | $0 to $40,400 | $0 to $54,100 | $0 to $80,800 |
15% | $40,401 to $445,850 | $40,401 to $250,800 | $54,101 to $473,750 | $80,801 to $501,600 |
20% | Over $445,850 | Over $250,800 | Over $473,750 | Over $501,600 |
Vs.
Ordinary Income Tax Rates for 2021
Ordinary Income Tax Rates | Single Filers | Married Filing Separate | Head Of House | Married Filing Jointly |
10% | $0 to $9,950 | $0 to $9,950 | Up to $14,200 | $0 to $19,900 |
12% | $9,951 to $40,525 | $9,951 to $40,525 | $14,201 to $54,200 | $19,901 to $81,050 |
22% | $40,526 to $86,375 | $40,526 to $86,375 | $54,201 to $86,350 | $81,051 to $172,750 |
24% | $86,376 to $164,925 | $86,376 to $164,925 | $86,351 to $164,900 | $172,751 to $329,850 |
32% | $164,926 to $209,425 | $164,926 to $209,425 | $164,901 to $209,400 | $329,851 to $418,850 |
35% | $209,426 to $523,600 | $209,426 to $314,150 | $209,401 to $523,600 | $418,851 to $628,300 |
37% | $523,601 or more | $314,151 or more | $523,601 or more | $628,301 or more |
So...what does all this mean? Let's take a look at an example. Please pay attention to the tables above.
Ordinary income is the starting point of where capital gains begin to be taxed as shown in each of our examples below. If ordinary income is below the 0% capital gains tax threshold, then the amount of capital gains up to the 0% threshold is taxed at 0%. Example: Single filer with $20,000 ordinary income (wages from a job) and $30,000 capital gains. The difference between $20,000 and $40,400 (the single filer threshold for 0%) would not be taxed. So $19,600 is not taxed. The amount over that (the difference between $30,000 and $19,600) would be taxed at 15%.
Example 1: Using a single filer as an example with $65,000 of taxable income. $15,000 of that $65,000 was from stock they bought and sold 3 months later (short-term gains) and the other $50,000 came from a Babe Ruth rookie baseball card they bought in 1981 (long-term gains).
This means that $15,000 is taxed as ordinary income because it's a short-term capital gain, and $50,000 is long-term capital gains and taxed as such.
For single filers making less than $40,400 between all work, capital gains, etc...they pay 0% tax on long-term capital gains.
The income over $40,400, but under $445,850 is taxed at 15%. In this example, the remaining income of $24,600 out of the $50,000 of capital gains is taxed at 15%. This equates to $3,690 in capital gains taxes. The total taxes due on this return would be $1,601 of ordinary income tax (the short-term capital gain) and $3,690 of capital gains income tax (the long-term capital gain) for a grand total of $5,291 in taxes due.
This example helps illustrate how ordinary income affects capital gains.
Example 2: If taxable income was still $65,000 ($50,000 from wages and $15,000 long-term capital gains) then the full $15,000 is taxable at the 15% tax rate. This is because $50,000 of income from wages is greater than the 0% threshold of $40,400. We just want to remind you that capital gains begin to be taxed after ordinary income (like wages).
In this case, the ordinary income tax due is $6,790, and capital gains taxes due are $2,250 for a grand total of $9,040 in taxes due.
Example 3: For comparison, if all taxable income of the $65,000 was ordinary income (wages), the tax due is $10,090 based on the 2021 ordinary income tax table.
If you'd like to learn more about how ordinary income is taxed according to our progressive tax system, check out our "Tax System" blog HERE!
Capital gains are generally taxed at a more favorable rate than ordinary income. For those who have capital gains, there are ways to help mitigate taxes. One such way is called tax-loss harvesting.
What about the new government proposal? The current government administration has put forth a proposal to add another tax bracket for those who make over $1 million. If you fall into that category of income, your capital gains would be taxed at 39.6%. This will not affect most taxpayers and looks to be designed to affect the top 1%. Capital gains harvesting is one way to try and mitigate those taxes. As of writing this blog, this is still a proposal and has not been enacted into law.
If you recently sold property, stocks, or other assets and would like to discuss the effects, please call our office at 770-420-2954 or schedule a call below!
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