When you buy stocks, you hope they go up in value so you can sell them at a higher price than you paid. That’s the whole idea, right? The good news is that you’ve made some money. The bad news is that the money you’ve made is taxable. It’s called capital gains because it’s the gain you made on the capital you invested. Understanding how capital gains are taxed will keep you from paying too much and help you keep more of your profits.
Here’s what you’ll find in this overview of capital gains tax on stocks:
- Short-Term and Long-Term Capital Gains
- How To Minimize Your Capital Gains Tax
- FAQ on Capital Gains Tax
- Capital gains are profits made from the sale of appreciating assets such as stocks.
- Capital gains tax is the tax levied on capital gains.
- Short-term capital gains are gains on assets you’ve held for 12 months or less.
- Long-term capital gains are gains on assets you’ve held for longer than 12 months.
- Tax-loss harvesting uses capital losses to offset capital gains and reduce tax.
- In addition to reducing the capital gains tax you pay on stock you’ve sold at a profit, tax-loss harvesting lets you take money out of a losing investment and put it into a more lucrative one.
Short-Term and Long-Term Capital Gains
There are two types of capital gains: short-term and long-term. Short-term gains are those gains on investments you have held for a year or less. Long-term gains are the gains on investments you’ve held for longer than a year. These two types of capital gains are taxed differently.
Short-Term Capital Gains Tax
Short-term capital gains are taxed at the same rate as your regular income. Suppose you and your spouse file jointly and you earn a total of $250,000 annually. This puts you in the 24% tax bracket, so you will pay 24% tax on your capital gain. Be careful that your capital gains don’t bump you up into a higher tax bracket.
Long-Term Capital Gains Tax
Long-term capital gains tax rates are also based on your income, but the rate is lower. If your income is $83,350 or less for a married couple filing jointly, you’ll pay 0%. If your income is over $83,350 but $517,200 or less, you’ll pay a 15% tax on your long-term capital gains. If your income is above $517,200, you’ll pay 20% tax on your long-term capital gains.
The income range for 15% capital gains tax for single filers is $41,675 to $459,750. For those who file as head of household, it’s $55,800 to $488,500, and for those who are married but file separately, it’s $41,675 to $258,600. Again, if your income is below the low end of this range, you will pay 0% tax, and if it’s above the threshold for the 15% rate, you’ll pay 20% tax.
How To Minimize Your Capital Gains Tax
The good news is that if you’re paying taxes because you sold stocks, it means you made money on your investment. That said, nobody wants to pay more than they have to. There are a couple of ways to make sure you pay as little in capital gains tax as possible.
Hold Your Stocks for at Least a Year
Long-term capital gains tax is almost always less than short-term capital gains. If you have a stock you’ve held for less than a year, consider waiting until the one-year mark has passed before you sell it. That way, you will be taxed at the lower, long-term capital gains tax rate.
Offset Your Capital Gains With Losses
You only pay taxes on your net investment gains — that is, the amount you gained minus the amount you lost. So if you are selling an investment on which you have a large gain, look to see if there are any other investments you can also sell that will generate a loss. The loss can offset your gain through a strategy called tax-loss harvesting.
Tax-loss harvesting lowers your tax bill. It allows you to sell a stock that’s losing money and use the loss to offset capital gains. In years when you have more capital losses than capital gains, you can use up to $3,000 of the difference to offset your capital gain. If your losses exceed $3,000, you can carry the remainder over to future years.
Here’s an example. Five years ago, Jane Investor, a teacher, bought 100 shares of ABC stock at $100 a share. She also bought 100 shares of XYZ stock at $100 a share. Today, ABC shares are selling at $150 per share, but XYZ shares have dropped to $20 a share. She wants to sell her ABC shares and take her profit of $5,000.
Jane doesn’t think XYZ is going to rebound any time soon, so she’s thinking of selling that stock. She’ll show a loss on XYZ of $8,000. She can use $3,000 of it to reduce the $5,000 gain she made on ABC stock. If she sells both stocks in the same year, she’ll only pay capital gains tax on $2,000 because she can offset $3,000 of her ABC gain with the XYZ loss.
There’s a certain order in which you must offset the gains. The first offset must apply to a like gain — short-term for short-term or long-term for long-term. If any of the $3,000 is left, it can be used to offset the opposite type of gain. And if there’s still money left after that, you can use it to reduce your regular income.
If your net loss is more than $3,000, you can carry the balance forward to subsequent tax years.
If you’re paying capital gains tax on stocks, it’s because you made a good investment that earned you some money, which is a very good thing. But watch your portfolio for underperforming stock you can sell at a loss to offset those gains. In addition to paying less tax, you’ll free up money you can then invest in a better-performing asset.
FAQ on Capital Gains TaxHere are the answers to some of the most frequently asked questions about capital gains tax.
- How much is capital gains tax on stocks?
- Short-term capital gains are taxed at the same rate as your regular income.
- Long-term capital gains are taxed at rates of 0%, 15% or 20%, depending on your filing status and overall income.
- How can you avoid capital gains tax on stocks?
- Holding your stocks for at least a year can lessen your tax burden because long-term capital gains tax is almost always less than short-term capital gains tax. You can also offset your gains with losses as you only pay taxes on your net investment gains.
- How do you calculate capital gains on stocks?
- To calculate capital gains on your stocks, you would add up any gain on the capital you have invested.
- Do you pay taxes on stock gains if you reinvest?
- Yes, you will still pay taxes on your stock gains even if you reinvest.
Daria Uhlig contributed to the reporting for this article.