Examining the question of when you pay capital gains tax has two components: first, what triggers the requirement to pay the tax, and second, what is the timing of the payment.
What Triggers The Requirement To Pay Tax On A Capital Gain?
A capital gain is an increase in the value of an asset, either an investment or real estate, that results in the asset having a higher worth than the basis of the asset. But the simple fact of an asset gaining value does not trigger a taxable event. To owe the tax, the taxpayer must realize the gain through a disposition of the asset. Suppose that you own a stock that consistently increases in value over the time that you own it. You may feel very wealthy because this asset that you purchased for $100 now has a value of $10,000. But until you sell the stock and receive the $9,900 in appreciation, you have not made a gain. It is possible that the day before you sell the stock, something will take place that results in the stock plunging to below the price you paid for it (your basis), and you have no gain, and thus no capital gains tax. Indeed, you have a capital loss that you can use to offset other gains.
Hopefully, though, you sell the asset while it is at the higher level, and you receive the benefit of the appreciation. Suppose you have owned the asset for less than a year. In that case, the profit (amount of increase over your basis, plus any other out-of-pocket costs and depreciation) will be taxed as a short-term capital gain, generally the same level as ordinary income. Ordinary income is usually made up of wages, commissions, and interest income, in addition to short-term capital gains.
If you have owned the asset for longer than one year, the gain will typically be subject to the tax rates of a long-term capital gain, which is generally lower than the rates for ordinary income. Currently, the federal rates for tax on long-term capital gains are 0, 15, or 20%, depending on your income. (There are some exceptional circumstances which may result in higher percentages, and the net investment income tax of 3.8% is added if a taxpayer meets certain requirements at a high-income level.) Keep in mind that some states also levy a capital gain tax. Most states tax capital gains and ordinary income at the same rate, but nine states tax long-term capital gains at a lower rate than ordinary income, and nine more have no capital gains tax (or income tax) at all.
When Do I Need To Pay The Capital Gains Tax From An Asset Disposition?
The taxpayer reports the capital gain, whether short or long term, on their next tax return. However, if you have a taxable event and the tax is due, you may need to make an estimated tax payment in advance of filing the return. If you fail to do so, you could face penalties and interest, depending on the amount due. The good news about reporting the gain is that you can offset the increase with any losses incurred during the same tax reporting period. Remember that short-term losses are used first to offset short-term gains, but any net losses remaining could be used to offset long-term capital gains (and vice versa).
Always consult your tax advisor about estimated tax payments, appreciation, and reporting issues.