Saving to build a financial nest egg is important in all stages of life. Investing some of your savings can be an effective way to grow your personal wealth and ensure a comfortable retirement.
Anytime you sell an investment for profit, you’ll generate a capital gain. These gains are taxed by the Internal Revenue Service at different rates depending on how long you held onto the asset and your income level. In this article we’ll take a close look at the different types of capital gains and also spend some time discussing how they are taxed.
Capital Gains Defined
Capital gains are the profits made by selling investments or capital assets. Gains can be generated from nearly any type of investment, including:
- Real estate
- Collectibles (stamps, coins, antiques)
- Personal property
Each of these investments or assets has a basis, which is the price you paid for the asset when you acquired it. A capital gain is the difference between your basis and selling price when there’s a profit, while a capital loss is the difference between your basis and selling price if you lost money.1
Here’s an example: You purchased 1,000 shares of a company (this one happens to be the world’s largest online retailer) in 2010 at $13 a share. When you sold those shares a decade later, the stock was trading at $160 a share. Your original basis was $13,000 – 1,000 shares at $13. Selling those 1,000 shares 10 years later netted a total of $160,000. Your capital gain is the difference between your basis in the stock and the sale price, which in this case equals $147,000.
Stock price in 2010 Stock price in 2020
Shares purchased: 1,000
Shares sold: 1,000 ($160,000)
Capital gain: $147,000
Your house also qualifies as a capital asset. If you sell it for a profit, you’ll generate a capital gains tax; however, you may qualify for an exclusion of up to $250,000 for single tax filers and $500,000 for married filers. To qualify, you had to live in and own the home for at least two of the last five years, and you can only claim the deduction once every two years.2
Short- and Long-Term Capital Gains Tax Rates
Short-term gains are generated on investments that are sold for a profit but held for less than one year. You will be taxed at your marginal tax rate.
Long-term capital gains taxes, meanwhile, are 15 percent for people or investors whose income falls into these categories:
- Less than or equal to $445,850 for single filers
- Less than or equal to $501,600 for married filers
- Less than or equal to $473,750 for head of household
- Less than or equal to $250,800 married filing separately
If your income exceeds these thresholds, you’ll pay the highest long-term capital gains rate of 20 percent. If your income is under $40,400, you’ll pay nothing.
The Bottom Line
Capital gains income is the profit made on investments that are sold for more than their purchase price. If you bought a business for $1 million and ran it for 10 years but decided it’s time to sell and retire, you’ll pay capital gains on the difference between your basis ($1 million) and the sale price. However, you can make adjustments to the basis through any capital improvements you made.
If you are considering selling an investment and know you’ll garner a tidy profit, you might consider consulting with a tax professional prior to divestiture to fully understand the tax consequences associated with the sale.
1 Capital Gains and Losses, IRS, https://www.irs.gov/taxtopics/tc409
2 Sale of your home, IRS, https://www.irs.gov/taxtopics/tc701
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.
Examples shown are for illustrative purposes only.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.