As can be the case with many IRS rules, the answer to the above is: It depends.
A capital asset is defined as anything that 1) has a useful life longer than one year; and 2) isn’t intended for sale in the regular course of a business’ operation. On a personal level, the IRS considers just about anything you use and own for purposes or as an investment as a capital asset. This includes stocks, bonds, homes, furniture, cars, jewelry, and coin or art collections.
Capital gains are an increase over what you originally paid for a capital asset (the basis). Determining what taxes to pay on that profit depends on how long you held onto that asset.
The IRS separates capital asset hold periods into “short-term” (less than one year) and “long-term” (greater than one year). This is an important distinction, as it determines what taxes you owe upon that asset’s sale. Specifically:
Profits generated from a short-term capital asset sale are taxed at the ordinary income rate. The ordinary income rate can range from 10% to 37%, depending on your tax bracket. If you’re a single filer and your income is between $89,075 and $170,050, your ordinary income rate (for 2022) would be 24%. This means if you sold a capital asset within a year of its purchase, the capital gains on that sale are taxed at 24%.
Profits generated from a long-term capital asset sale are taxed at the capital gains rate. This can range from 0% to 20%, once again depending on your income bracket. So, if you’re a single filer and your income is from $41,675 to $459,750, your capital gains are taxed at 15%.
Some strategies could be helpful when deferring or reducing capital gains taxes. For example, if you sell your house, the IRS offers some capital gains exclusions from the sale.
If you use real estate for business or investment purposes, using a 1031 exchange to "swap" that asset for another could help defer taxes. Keep in mind that the like-kind exchange is useful only for real estate investments.
It’s important to understand that any capital asset sale (assuming you earn a profit) means you owe taxes. How much you owe depends on the length of the hold and/or any tax deferment strategies you might consider. As always, it’s a good idea to work with your tax advisor when it comes time to sell any capital assets.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.