Personal finance is a complicated and convoluted topic. There’s a lot of lingo, and financial advisors often want your money before they give you advice and information. In our financial wellness series, we’ve tried to demystify some common and important topics, covering salary negotiation, the basics of investing, and budget tools.
But today, we wanted to cover something a little more jargon-y that goes more in-depth on an investing topic. Learning to invest money is important for your financial wellness, and it’s more than just having a stock portfolio or buying random shares on an app like Robinhood.
Today we’re covering capital gains: what they are, long-term versus short-term capital gains, and how to make choices that benefit your financial wellness. If that sounds stuffy and boring, well, we’re going to make it as interesting as possible, and it’s kind of like medicine. It’s for your own good.
What Is Capital Gains Tax, Anyways?
Great question, and a good starting place. According to TurboTax, a capital gain “occurs when you sell something for more than you spent to acquire it.”
TurboTax says every taxpayer should know about capital gains because they’re taxed, and they don’t just include stock profits. Capital gains are any personal investment, including jewelry, stock options, property, and more—even a big-screen TV.
“Anyone who sells a capital asset should know that capital gains tax may apply. And as the Internal Revenue Service points out, just about everything you own qualifies as a capital asset,” TurboTax says.
In short, if you sell something for a profit, you have to report it on your taxes. But how much you’re taxed depends on your “basis,” or what it cost to acquire, improve, and sell the asset. This can include:
- Sales taxes and other taxes and fees
- Shipping and handling costs
- Installation and setup charges
- Depreciation of the asset
- Money invested to improve the asset and increase its worth
All these can increase your basis and therefore reduce how much your profit is taxed.
How long you’ve held an asset affects how much you’re taxed because they fall into two categories: short-term gains or long-term gains.
What Is A Long-term Capital Gain, And What’s A Short-term Capital Gain?
As mentioned, tax rates for capital gains can depend on how long you’ve held the asset. According to The Balance, you will pay a higher tax on investments you hold for less than a year, while paying less if you hold them for longer than that. This is one way the U.S. government and the IRS encourage long-term investing.
“Assets that are held for less than a year are taxed at the same rate as your normal income. Assets held longer will be taxed at a long-term rate, which is 15% for most people,” according to The Balance’s website. “It is 20% for individuals who make more than $441,450 and zero if you earn less than $80,000.”
TurboTax also defines long-term capital gains as those held longer than a year, and short-term gains as those held less than a year. It’s worth noting that business income is not considered a capital gain, according to the same site.
You can find a more complete chart and bracket illustration for capital gains taxes, and long-term vs short-term capital gains, on Investopedia.
How To Avoid Capital Gains Tax
There are a few ways to reduce your capital gains so that when you do eventually sell an asset, you won’t owe as much money. Keep in mind that both the federal and state governments can tax you if state income tax applies. According to Investopedia, the following states don’t have state income tax or they don’t tax capital gains. If you live in one of these states, you’ll pay less for assets you sell.
- Alaska, Florida, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming do not have state income tax.
- Colorado, Nevada, and New Mexico do not tax capital gains. Montana has a credit to offset part of capital gains taxes.
Other types of capital gains, like real estate investments or stocks that come with exceptions, may not be taxed the same way. Investopedia has a pretty in-depth list of those types of special exemptions, but we won’t include those lists here since they’re somewhat uncommon.
Should I Hold My Investments For Long-term Capital Gains Or Not?
Most tax rates on capital gains will be lower if you hold them for more than a year. If short-term capital gains are taxed in your state, it might pay to wait.
Of course, not every investment is meant for the long term. You could theoretically flip a house in less than a year and sell it for a profit. In that case, Nerdwallet has a good capital gains tax calculator you can use to get an estimate of what you might pay in associated taxes.
While you don’t always need to consult a financial advisor for day-to-day spending or even filing your taxes—plenty of people do them online every year—if you have questions about your assets, capital gains taxes, tax rate, how long to hold an investment, or even just how to invest money in a way that best contributes to your financial wellness, you may consider seeking expert help.
There’s no such thing as a dumb question, and financial advisors are there to help! For in-depth questions, find someone who can give you a personalized, detailed answer to prevent problems or financial wellness obstacles.