Capital Gains Tax is the tax many more of us are unfamiliar with and applies to many assets. Learn the fundamentals of Capital Gains Tax in our guide, including what Capital Gains Tax is and when you'll pay Capital Gains Tax.
What is Capital Gains Tax?
Capital Gains Tax is a specific type of tax levied on any profit when a capital asset is disposed of. In this context, disposed refers to an asset being sold, or sometimes traded or gifted, depending on where you live.
Profits from disposing of a capital asset are also known as capital gains, while losses from disposing of a capital asset are known as capital losses.
What are capital assets?
A capital asset is anything - tangible or intangible - of value that can be converted into cash. An asset is typically acquired as some sort of investment, with the intention to cash out one day in the future. Individuals can own assets, and these are called personal assets. Assets can also be owned by a business, as fixed or current assets.
Either way, an asset can be tangible or intangible:
- Examples of intangible assets include computer software, stocks, licenses, trademarks, patents, films, copyrights, and crypto.
- Examples of tangible assets include investment property, personal property jewelry, collectibles such as art, antiques, wine, shares, and office equipment.
What do you pay Capital Gains Tax on?
You'll pay Capital Gains Tax on any gain you make as a result of disposing of a capital asset - including both tangible and intangible assets.
If you have a loss from disposing of a capital asset, it's not all bad news. You can generally offset capital losses against capital gains, to reduce your overall tax liability. But there are some specific rules you need to know about!
How does Capital Gains Tax work?
There are many Capital Gains Tax rules you need to know about to fully understand your potential tax liability. Starting with short-term vs. long-term capital gains.
Short vs. long-term capital gains
There are different tax rates for short-term gains from assets you've held for less than a year and long-term gains from assets you've held for more than a year. Short-term gains are generally subject to your individual Income Tax rate, while long-term gains are subject to a much lower long-term Capital Gains Tax rate, which is generally up to a maximum of 20%. The income thresholds change slightly each year, but we have dedicated content to help you find out about the most up-to-date Capital Gains Tax rates.
All this said, there are some specific exceptions when you may pay a higher rate of tax than 20% on capital gains.
Capital Gains Tax rules
There are three exceptions where you may pay more than 20% in tax on capital gains. These include:
- Long-term capital gains from selling collectibles (like coins, art, or even NFTs deemed collectibles) may be taxed at a rate of up to 28%.
- The taxable portion of a gain from selling section 1202 qualified small business stock may be taxed at a rate of up to 28%.
- Unrecaptured section 1250 gains from selling section 1250 real property may be taxed at a rate of up to 25%.
Net Investment Income Tax
Taxpayers with significant investment income may also be liable to pay Net Investment Income Tax (NIIT). NIIT is a flat 3.8% rate and applies to specific net investment income for individuals, estates, and trusts with income above a given threshold. For individuals, the thresholds are as follows:
Learn more about NIIT for trusts and estates in the NIIT IRS guidance.
Capital losses may be offset against capital gains to reduce your net gain, but there are more rules to consider. If your capital losses exceed your gains, you can claim an excess loss of up to $3,000 against ordinary income. If you have a larger capital loss than this, you may carry your loss forward to future financial years to utilize.
Calculating capital gains and losses
Your capital gain or loss is the difference in price from when you acquired your asset, to when you disposed of it. This is also known as your cost basis.
Your cost basis is whatever your asset cost you, plus any allowable expenses like purchase or sale fees. To calculate a gain or loss, simply subtract your cost basis from your sale price.
Cost basis for multiple assets of the same kind
Where you have multiple assets of the same kind - like stocks or cryptocurrency - the IRS is clear that you should generally specifically identify these if possible. If this is not possible, there may be multiple accounting methods available including FIFO, HIFO, and LIFO.
How do I avoid Capital Gains Tax?
Legally, you cannot outright avoid Capital Gains Tax on taxable gains. However, popular options to reduce or defer tax include utilizing tax-deferred retirement plans like 401(k)s, 403(b)s, or individual retirement accounts (IRAs). Many of these tax-advantaged accounts allow you to buy and sell investments including capital assets within your retirement account without triggering Capital Gains Tax.
No. Generally, though Capital Gains Tax is due on any gain following the disposal of a capital asset, this is often not fully due until your tax return in the subsequent financial year. For example, if you sold a capital asset in 2023, tax may not be due until your annual tax return in Spring 2024.
However, in some instances, the IRS requires quarterly estimated taxes and you may face penalties for failing to pay estimated taxes.
More questions about capital gains? We got you covered.
Which capital assets are collectibles?
In the current guidance from the IRS, collectibles may include:
- Any work of art
- Any rug or antique
- Any metal or gem (with limited exceptions)
- Any stamp or coin (with limited exceptions)
- Any alcoholic beverage
- Any other tangible personal property determined a collectible by the IRS
That last bullet point matters because the IRS has recently clarified that NFTs that represent an underlying asset that is a collectible may also be taxed as such. You can learn more in our NFT tax guide.
Where do I report capital gains and losses?
You report capital gains and losses to the IRS in your annual tax return. Each disposal should generally be reported in Form 8949, with a summary of gains and deductible losses in Schedule D (Form 1040).
Is capital income tax-advantaged?
Yes. Generally speaking, capital income from long-term gains is taxed at a much more advantageous rate than ordinary income or short-term gains.
Do I pay Capital Gains Tax on cryptocurrencies?
Yes. You'll pay Capital Gains Tax on any capital gain from selling, swapping, or even spending cryptocurrency. Learn more in our crypto taxes guide or sign up free to Koinly to calculate your crypto taxes in minutes.
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