When Does Capital Gains Tax Apply?

You sold your house, an investment property, or something else of value. When do you tell the Internal Revenue Service (IRS)? While tax law can seem overwhelming for many Americans, we’re here to help you make sense of it. Below, you’ll learn how capital gains taxes work, when to make estimated tax payments, and how to minimize your tax liability.

At a glance:

• If you sell an asset you own for a year or less, the proceeds are taxed like ordinary income.
• If you held the asset for over a year, you’re taxed at long-term capital gain tax rates, which are generally lower.
• You can use other tax events like selling depreciated assets or contributing to charity to offset capital gains tax.

What are capital gains?

Capital gains refer to the profit you make when you sell a capital asset for more than its purchase price. These can include assets like real estate, mutual funds, collectibles, cryptocurrency, and even small business stock. However, not all capital gains are taxed equally, which is where the concept of long-term capital gains and short-term capital gains comes in.

Short-term capital gains tax rates

If you held an asset for one year or less before selling, the profit is considered a short-term capital gain. These gains are taxed at your ordinary income tax rate, which can make them more costly. For example, if you sell stocks after six months for a $10,000 profit and have a 24% federal tax rate, you’ll owe $2,400 in taxes on that gain.

Can’t remember which tax bracket you’re in? Check the 2024 tax brackets here.

Long-term capital gains tax rates

Assets held for more than one year are subject to long-term capital gains tax rates, which are typically lower. Here are the long-term gain rates for tax year 2024:

For example, if you’re in the 24% tax bracket ($100,526 to $191,950 in 2024), your long-term capital gains tax rate is likely only 15%, based on the chart above. For some taxpayers in the lowest tax brackets (10% or 12%), the rate might even be tax-free at 0%. This is why holding assets longer can be beneficial from a tax treatment standpoint.

Will I pay additional taxes because of capital gains?

Before you stress about paying taxes on that house sale or profitable stock trade, you need to determine how much your tax bill will increase — if at all.

How to estimate your capital gains tax

Check out our capital gains tax calculator to estimate your taxable capital gain. When selling assets, it’s crucial to know your cost basis (i.e., what you originally paid) and the sale price. The difference between these two is your taxable income from the sale.

You can also calculate it based on your tax bracket — try using our income tax calculator to estimate how a sale might affect your overall taxable income.

Special cases: primary home sale and collectibles

The sale of your primary residence may offer an exemption from capital gains taxes. For instance, homeowners may exclude up to $250,000 as a single filer ($500,000 for married filing jointly) of the gain from the sale of their primary residence under certain conditions. On the other hand, selling collectibles like art or vintage cars incurs a higher capital gains tax rate of up to 28%.

Estimated tax payments and capital gains

Why worry about estimated tax payments?

The IRS may require you to make estimated tax payments for any income not subject to withholding. If the sale of an asset leads to significant capital gains, you may need to pay quarterly taxes on the amount. Failing to do so can result in penalties and interest charged on the amount you should have paid. Generally, you must make estimated payments if you expect to owe more than $1,000 when filing your tax return and your withholding is less than 90% of your current year’s tax liability or 100% of your previous year’s taxes.

Alternatives to estimated tax payments

Instead of making quarterly payments, you could adjust your income tax withholding to account for the additional tax. You can increase your withholding by filing a new Form W-4 with your payroll department.

How tax brackets impact your capital gains

Capital gains can push you into a higher tax bracket, but the good news is that not all gains are taxed at the higher rate when this happens. Only the portion of the gain that falls into the higher bracket will be taxed at the corresponding rate.

For example, say you are a taxpayer in the 12% marginal tax bracket before any capital gains. You sell a parcel of land that is a capital asset for a capital gain of $50,000, pushing you into the 22% marginal tax bracket. In this instance, you would pay 0% of capital gains tax on the amount of capital gain that fits into the 12% marginal tax bracket. The remaining portion of the capital gain that pushes you into the 22% marginal tax bracket is then subject to a 15% capital gains tax.

The effect of capital gains on adjusted gross income

Selling a valuable capital asset might also increase your adjusted gross income (AGI). This could potentially reduce the tax deductions or tax credits you’re eligible for, impacting your overall tax liability. In some cases, a higher AGI can subject you to additional taxes like the net investment income tax (NIIT) if you’re a high-income taxpayer.

Ways to minimize your capital gains tax

1. Use of capital losses to offset gains.

If you’re staring down a big tax bill from capital gains, consider selling an asset that’s depreciated in value. Capital losses can offset capital gains, reducing the tax you owe. However, you must match short-term losses with short-term gains first, and the same applies to long-term gains and losses. You can also carry over excess capital losses to future years.

2. Find ways to lower your taxable income.

To minimize your taxable income, consider strategies like tax-loss harvesting, contributing to charity, or investing in tax-advantaged accounts like an IRA or another retirement account.

Understanding the IRS rules for capital gains

The IRS tracks all taxable capital gain events, even if you don’t report them. Forms like Form 1099-S for real estate transactions ensure the agency is aware of your sale, so it’s essential to report everything accurately on your tax return.

Be aware the IRS requires extra scrutiny for high-value assets, particularly for complex transactions involving depreciation, wash sales, or the sale of cryptocurrency and other financial instruments like mutual funds.

The bottom line

Understanding how capital gains taxes work can save you from unpleasant surprises at tax time. Whether it’s navigating short-term gains, strategizing your long-term capital gains tax rates, or finding smart ways to lower your tax liability, being informed is your best defense. And don’t forget: If you need help along the way, TaxAct is here to make tax season less of a headache.

This article is for informational purposes only and not legal or financial advice.

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