The idea that financial gains tend to result in taxation is fairly intuitive for most people to grasp. When it comes to the specifics of capital gains, however, things are not so straightforward. Below are some frequently asked questions about capital gains.
If I sell an investment I’ve held for more than a year for more than I paid, will I have to pay taxes?
If you purchased a stock for $100 several years ago and sold it today for $150, you will have to pay long-term capital gains tax on that $50 gain. Federal long-term capital gains tax rates are lower than ordinary income tax rates, but still depend on your total taxable income (including capital gains). For 2021, the rates are as follows:
- Those with taxable income of $40,000 or less ($80,000 or for a married couple) would not have to pay any capital gains tax.
- Those with taxable income of $40,001 to $441,450 ($80,001 to $496,600 for a married couple) would pay 15% on capital gains.
- Those with taxable income over $441,450 ($496,600 for a married couple) would pay 20% on capital gains.
What if the investment I sell is in a 401(k), IRA or other retirement account?
There is no taxation owed on investment gains within a retirement account. Taxation on these accounts is determined by contributions and withdrawals, not investment gains.
What if I sell other investments for a loss?
If you sell some investments in a non-retirement account for a gain and others at a loss, the losses can be used to offset the gains. If you still have a net gain remaining when all sales are added up, you will owe capital gains tax on that net amount. If the amounts add up to a net loss, then you can use that to reduce your income for tax purposes by up to $3,000 in a given year (that amount is the same for both individuals and married couples). If your net loss exceeds $3,000, you can carry that amount forward into future tax years to offset capital gains or income.
What if I sell an investment after holding it for a less than a year?
If you realize capital gains on an investment that you’ve held for less than one year, that gain will be taxed at your ordinary income tax rate, which is higher than your capital gains rate. You can add this to the long list of reasons that it’s important to invest with a long-term view.
Will I owe anything to the state?
Everything discussed so far relates to federal capital gains taxes. Most states also tax capital gains, but the rates and methodologies used vary from one state to the next. An interactive graphic with capital gains tax for each state can be found here.
Any other taxes?
In addition to capital gains tax, you may also be subject to the net investment income tax. This is a 3.8% tax levied on net investment income (including interest, dividends, capital gains, rental and royalty income, and non-qualified annuities) above $200,000 for an individual or $250,000 for a married couple.
Planning for gains
Capital gains taxes can be complicated. While taxes shouldn’t be the only guiding factor in managing your investments, it’s important to understand the role of capital gains taxes and how they can be managed as part of a prudent long-term investment strategy.
