Capital gains can have tax benefits over regular income, specifically long-term capital gains. That’s because long-term capital gains have a lower tax rate than regular income and short-term capital gains, which are also taxed at the regular income tax rate.
But capital gains are still income. That being the case, do capital gains count toward your income tax bracket, potentially pushing you into a higher tax bracket?
What Are Capital Gains
Capital gains are profits on capital assets such as bonds, stocks, mutual funds, real estate, collectibles, and cryptocurrency. There are two types of capital gains based on holding periods. Short-term capital gains are held for up to one year and taxed at a filer’s ordinary income tax rate. Long-term capital gains are held for more than a year and have a lower tax rate.
Capital gains are included in AGI, which is adjusted gross income. AGI includes your income minus various adjustments or deductions. But does this mean capital gains can push you into a higher tax bracket?
Capital Gains And Your Tax Bracket
The U.S. income tax system is progressive. Income is progressively taxed at higher rates. You can be taxed at a higher rate on the additional earnings as you earn more.
Your income is broken into different tax schedules with different rates. There are schedules for each of the following:
- Regular Income Tax
- Estates and Trusts
- Alternative Minimum Tax
- Long-term Capital Gains
- 3.8% Net Investment Income Tax (NIIT)
Because your regular income is taxed on one schedule and your long-term capital gains on another, regular income tax brackets are not affected by capital gains. To see this, let’s look at an example.
A married couple filing jointly has an income of $80,000 per year. During this same year, the couple sold a rental property for $120,000, which they’ve had for three years. Their AGI is $200,000.
They take the standard deduction of $25,900. Their taxable income is $174,100. This couple will fall into the 12% federal tax bracket:
10% — $0 - $20,550
12% — $20,551 - $83,550
22% — $83,551 - 178,150
While it appears that they’ve been pushed into a higher tax bracket at 22%, the $120,000 is not taxed against the regular income tax brackets. Instead, it is taxed against the long-term capital gains tax brackets. This leaves $54,100 as regular income, putting them into the 12% tax bracket.
Below is the long-term capital gains tax schedule.
0% — $0 - $83,350
15% — $83,351 - $517,200
20% — greater than $517,201
The couple’s taxable income is $174,100 ($120,000 + $54,100). However, the $120,000 in long-term capital gains is taxed as follows:
$83,350 = zero taxes
$90,750 = 15% or $13,612.50
If the couple would have had a capital gains loss, it would have reduced their $120,000 gain and their long-term capital gains tax bill.
Calculating taxes owed can be complex and unique to each tax filer. It’s best to work with a tax accountant when calculating your taxes owed.
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.
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.
Hypothetical examples are for illustrative purposes only.