Did you make a profit on the sale of a house, some investments, or even a car this year? If so, you’ll likely need to report the sale on your return due to the long-term capital gains tax.
Fortunately, if your sale qualifies as a long-term capital gain, the taxes are less than what you’d pay on your ordinary income, such as wages.
To qualify as a long-term gain, you must own a capital asset, meaning that house, investment or car you sold, longer than one year. In that case, you generally qualify for the special tax rates. A short-term capital gain includes the profits of an item you sold that you owned for less than one year. That gain is taxed at the same rate as your ordinary income.
Here’s what else you need to know to manage your long-term capital gains.
Do I have a long-term capital gain?
Most things you own, such as your car, investments, and real estate are capital assets. And when you sell those assets, a capital gain or loss is created.
Long-term capital gains occur when you:
- earned more from the sale of a capital asset than your basis in the asset
- kept the asset for longer than one year
Note: Gains on certain types of assets, such as collectibles and property for which you have taken depreciation deductions, are subject to special rules. Here are 7 ways investment gains and losses affect your taxes.
How much tax do I owe?
Depending on your income level you can pay anywhere from $0 to 20 percent tax on your long-term capital gain. Additionally, capital gains are subject to the net investment tax of 3.8 percent when the income is above certain amounts.
With the Tax Cuts and Jobs Act signed into law in December 2017, long-term capital gains rates are applied based upon ordinary income amounts. The brackets are:
| Single | Joint | |
|---|---|---|
| 0% tax bracket | $0 – $41,675 | $0 – $83,350 |
| 15% tax bracket | $41,676 – $459,750 | $83,351 – $517,200 |
| 20% tax bracket | $459,751 and above | $517,201 and above |
Example: Say you bought ABC stock on March 1, 2010, for $10,000. On May 1, 2018, you sold all the stock for $20,000 (after selling expenses). You now have a $10,000 capital gain ($20,000 – 10,000 = $10,000).
If you’re single and your income is $65,000 for 2018, you would be in the 15 percent capital gains tax bracket. In this example, that means you pay $1,500 in capital gains tax ($10,000 X 15 percent = $1,500). That amount is in addition to the tax on your ordinary income.
One caveat does exist with the sale of personal residences. You may not have to pay tax on up to $250,000 gain from the sale of your home. That rule applies if you owned and lived in the house for at least two of the last five years or if you meet certain exceptions.
In the case that you’re married, you can exclude up to $500,000 in gain from the sale of the home as long as you meet the requirements.
Do I have to pay the additional tax on net investment income?
You may have to pay an additional 3.8 percent tax on net investment income.
You pay this tax if your modified adjusted gross income is $200,000 or more ($250,000 if filing jointly, or $125,000 if married filing separately). You can reduce your investment income for that tax by deducting investment interest expenses, advisory and brokerage fees, rental and royalty expenses, and state and local income taxes allocated to your investment income.
The 3.8 percent tax applies to investment income, such as interest, dividends, capital gains, rental, and royalties It’s paid in addition to the tax you already pay on investment income.
What you should know before you sell?
If you’re thinking about selling assets, such as stock, it’s best to plan ahead. A little planning now can save you lot of capital gains tax later when you file your return.
Consider these options:
Don’t sell before the profit qualifies as long-term. Plan the sale of an asset that’s gone up in value to be a long-term gain. Make sure to hold the asset long enough to qualify for long-term status. For most assets, that’s more than one year. Don’t be too hasty to sell when the year is up. The IRS guides say you must own the asset for “more than one year.” If it’s exactly one year when you sell, there’s a good chance they could classify it as a short-term sale.
Don’t hang on to losing investments just to avoid taking a loss. Consider selling assets at a loss to offset capital gains. Remember that sound investing generally trumps tax avoidance.
There are worse things than owing taxes. Losing money or keeping your money in something that doesn’t go up in value is one of them.
Give stock that has gone up in value to charity. Call it a loophole if you like, but here’s a great tax break. If you donate stock to charity, you get a tax deduction for the amount it’s worth now. Also, you don’t have to pay capital gains tax on it.
Don’t sell all at once. Even if you’re not normally in the higher income tax bracket, one large sale can place you there for the year if you’re not careful. You might want to sell some stock one year and wait until January to sell some more.
Take the proceeds as an installment sale. If you have real estate you’ve been holding for 30 years, don’t let the sale bump you into the top tax bracket in the year of the sale. Consider making an installment sale. Besides saving taxes, you’ll create a steady flow of income for yourself.
Plan for a 1031 exchange. If you sell an asset and purchase a “like-kind” property, you may qualify to put off paying tax on the gain from the first property. The idea behind this rule is that you don’t realize a gain when you sell one asset to buy another one. Be sure to plan a 1031 exchange carefully.
Look for other ways to reduce your income tax bracket in the year of the sale. If you’re selling a substantial capital asset for a profit, that may be a good year to sell a different asset at a loss, contribute more to charity or a retirement account, invest in your business, or take other tax-saving steps.
Buy and hold. The simplest way to put off paying tax on capital assets is to hang on to them. Perhaps the capital gain rate will come down. It’s happened before! Or you may be in a lower tax bracket in a later year, such as after you retire. In any case, you can let your investments continue to grow by simply leaving them be.
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