When you sell investments, you don’t pay taxes on the entire sale price, just your profits. But, that’s not all: Depending on how long you held the investment, you could qualify to pay taxes at the lower capital gains rates. Understanding how capital gains are taxed can help you avoid a big tax hit when you sell your investments.
Capital Gains Tax Rates
The tax code offers a lower long-term capital gain tax rate than then the individual tax rate for ordinary income, which is also the short-term capital gain tax rate. The 2018 capital gains tax rate depends on your total income, but don’t line up exactly with specific tax brackets as in the past. Though additional legislation could be passed at any time, the current tax rates will be the same except for inflation adjustments to the amounts listed in the table.
Here are the capital gains tax rates broken out by filing status and income:
|Capital Gains Tax Rates|
|Tax Rate Applicable to Long-Term Capital Gains||Single||Married Filing Separately||Head of Household||Married Filing Jointly|
|0%||$0 to $38,600||$0 to $38,600||$0 to $51,700||$0 to $77,200|
|15%||$38,600 to $425,800||$38,600 to $239,500||$51,700 to $452,400||$77,200 to $479,000|
|20%||Over $425,800||Over $239,500||Over $452,400||Over $479,000|
|Information accurate as of Aug. 1, 2018.|
Short-Term Versus Long-Term Capital Gains
To qualify for the lower long-term capital gain rates, you must own the asset for more than one year before you sell it. If you sell it after owning it for a year or less, the gain is classified as a short-term capital gain for tax purposes, which means the income is taxed at the same, higher rates as your other income, like your wages and salaries. For dividend income from an American or qualified foreign corporation, the long-term capital gains rate applies if you own common stock for at least 61 days out of the 121-day period starting 60 days before the ex-dividend date. For preferred stock, the dividend tax is at the long-term capital gains rates as long you own it for at least 91 days out of the 181-day period starting “90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days,” according to the IRS.
Minimizing Your Tax Hit
You might be required to make estimated tax payments when you have a large capital gain. For many people who have almost all of their taxable income from wages, the income taxes withheld from their paychecks is sufficient to avoid any penalties. However, if you have a large capital gain, you might need to make estimated payments. Generally speaking, to avoid penalties, your withholding and estimated payments must equal at least 90 percent of your tax liability for the current year or 100 percent of what you owed in taxes for the prior year.
In addition, the income is reported in the year you sell the assets, so you could consider spreading your sale over multiple years. For example, if you are planning to sell your $50,000 position in a single stock, you might sell half in December and half in January to spread the tax hit over two years. In addition, this could also help keep you below the net investment income tax in a given year. The net investment income tax is a 3.8 percent tax that applies to the lesser of your net investment income, including long-term capital gains, or the amount by which your modified adjusted gross income exceeds $250,000 if married filing jointly or a qualifying widow or widower, $125,000 if married filing separately, or $200,000 if using any other filing status. You can also reduce your tax hit by selling some of your big gainers in a year that you have a capital loss to offset some of the income.
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