The U.S. income tax code, officially designated the Internal Revenue Code (IRC), is a large document that was enacted by the U.S. Congress through Title 26. Additional tax guidance is located in Treasury regulations, sometimes referred to as federal tax regulations.
Within these regulations is information about the standard deduction and capital gains. These topics aren’t similar to one another (except that they might have an impact on your taxes). But one can impact the other. The answer to the question “does the standard deduction apply to capital gains?” is technically yes, as the standard deduction applies to all taxable income (though capital gains tend to be taxed at a lower rate).
A better question to ask is how the standard deduction actually might impact your capital gains taxes.
Explaining the Standard Deduction
According to the IRS, the standard deduction is “a specific dollar amount that reduces the amount of income on which you’re taxed.” But this deduction varies, depending on year, filing status (for example, if you’re 65 years or older and/or blind), or whether you’re claimed as a dependent.
Also, you’re not entitled to the standard deduction if you itemize your deductions. Basically, your choice is between a standard deduction and itemized deduction.
So, if you’re opting for a standard deduction, that amount is subtracted from the amount of income on which you’re taxed. On the federal level, the 2022 standard deduction ranges from $12,950 (for a single filer) to $25,900 (for those who are married and filing jointly or surviving spouses). If you pay state income tax, each state might have its own standard deduction guidelines.
Standard Deductions and Capital Gains
A standard deduction might influence capital gains if that deduction impacts the tax bracket you’re in. Here’s a refresher on how capital gains from capital asset sales are taxed:
- Short-term holds (less than a year) mean capital gains are taxed at the ordinary income rate.
- Long-term holds (a year or longer) mean any capital gains are taxed at the capital gains rate.
Both ordinary income and capital gains rates depend on your income tax bracket. In other words, how much you’ve earned. If the standard deduction reduces your overall income, you could pay less in capital gains.
Here’s a hypothetical situation, suppose you sell real estate that you owned for three years. You might earn a profit (or capital gain) of $6,000. Meanwhile, your taxable income might be $43,000 for the year, meaning your capital gains tax rate would be 15%.
However, if you subtract the standard deduction of $12,950 from that $43,000, you’d end up with a taxable income of $30,050. This drops you into a lower tax bracket, meaning you might owe nothing in capital gains taxes.
The same example could also be used for short-term asset holds, but the tax brackets are different. As another hypothetical, if your taxable income as a single filer is $87,000 and you subtract the standard deduction of $12,950, your taxable income is then $74,050. This drops you from the 24% tax bracket to the 22% tax bracket, meaning the capital gains tax is 22%.
Needless to say, the above are examples of how the standard deduction might impact capital gains taxes. But to ensure that you know how much you’re taxed on capital gains, be sure to consult with your tax professional.
Examples shown are for illustrative purposes only.
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.
