A capital gain refers to the increase in the value of a capital asset when it is sold. Put simply, a capital gain occurs when you sell an asset for more than what you originally paid for it.
Almost any type of asset you own is considered a capital asset. This can include investments like stocks, bonds, or real estate as well as personal property like furniture or a boat.
Capital gains are realized when you sell an asset, calculated by subtracting the original purchase price from the sale price. In certain circumstances, the Internal Revenue Service (IRS) taxes individuals on these gains.
Key Takeaways
- A capital gain is the increase in a capital asset’s value, realized when the asset is sold.
- Capital gains can apply to any type of asset, including investments and personal property.
- Gains can be short-term (one year or less) or long-term (more than one year) and must be reported on income taxes.
- Unrealized gains and losses reflect an asset’s value change but aren’t taxable until realized.
- A capital loss occurs when there is a decrease in the capital asset value compared to its purchase price.
Lift the Curtain on Capital Gains
Capital gains represent the increase in an asset’s value and are typically realized when the asset is sold. These gains are often associated with investments, such as stocks and funds, due to their inherent price volatility. However, any security or possession sold for more than its original purchase price can generate capital gains—for example, a home, furniture, or vehicle.
Capital gains are categorized into two types:
- Short-term capital gains: Realized on assets sold after holding them for one year or less.
- Long-term capital gains: Realized on assets sold after holding them for more than one year.
Both types must be claimed on your annual tax return. Understanding this distinction is vital for individuals involved in frequent trading or investment.
Realized capital gains incur a taxable event when an asset is sold. Unrealized gains (also known as paper gains and losses) reflect changes in investment value but aren’t taxed until realized. For instance, if your stock increases in value but you haven’t yet sold it, it’s an unrealized capital gain.
Short- and Long-term Capital Gains Tax Rates
Long-Term Capital Gains Tax Rates for 2023
| Filing Status | 0% Tax Rate | 15% Tax Rate | 20% Tax Rate |
|---|---|---|---|
| Single | Up to $44,625 | More than $44,625 but less than or equal to $492,300 | Above $492,300 |
| Married filing jointly | Up to $89,250 | More than $89,250 but less than or equal to $553,850 | Above $553,850 |
| Married filing separately | Up to $44,625 | More than $44,625 but less than or equal to $276,900 | Above $276,900 |
| Head of Household | Up to $59,750 | More than $59,750 but less than or equal to $523,050 | Above $523,050 |
Long-Term Capital Gains Tax Rates for 2024
| Filing Status | 0% Tax Rate | 15% Tax Rate | 20% Tax Rate |
|---|---|---|---|
| Single | Up to $47,025 | More than $47,025 but less than or equal to $518,900 | Above $518,900 |
| Married filing jointly | Up to $94,050 | More than $94,050 but less than or equal to $583,750 | Above $583,750 |
| Married filing separately | Up to $47,025 | More than $47,025 but less than or equal to $291,850 | Above $291,850 |
| Head of Household | Up to $63,000 | More than $63,000 but less than or equal to $551,350 | Above $551,350 |
Special Considerations for Capital Gains Tax
Certain stocks or collectibles may be taxed at a higher 28% capital gains rate, and real estate gains can reach up to 25%. If capital gains push your income over the 15% threshold, the excess is taxed at 20%.
Not all capital losses are deductible. For example, selling your house or car at a loss does not deduct the difference on your taxes. However, selling your primary residence has an exemption: the first $250,000 of your gain ($500,000 if married) is excluded from capital gains tax.
High-net-worth individuals may need to pay additional taxes, such as the net investment income tax, on top of the 20% capital gains tax.
Optimize Your Asset Portfolio: Eligible Investments for Capital Gains
Different assets have different eligibility for capital gains tax treatment. Below is a comparison chart.
| Eligible Assets | Not Eligible |
|---|---|
| Stocks | Business inventory |
| Bonds | Depreciable business property |
| Jewelry | Real estate used by your business or as a rental property |
| Cryptocurrency (including NFTs) | Copyrights, Patents, and Inventions |
| Homes and Household furnishings | Literary or Artistic Compositions |
| Vehicles | |
| Collectibles | |
| Timber | |
| Fine artworks |
Mutual Funds and Capital Gains: Maximize Returns Adaptively
Mutual funds that realize capital gains throughout the year must distribute these gains to shareholders, commonly before the end of the calendar year.
Shareholders receive a distribution notice with a Form 1099-DIV, detailing short- and long-term gains. This distribution causes a decrease in the fund’s net asset value (NAV) by the sale amount. However, it does not affect the fund’s total return.
Tax-aware investors should assess a mutual fund’s unrealized accumulated capital gains before investing, as funds with a significant unrealized capital gain push can trigger taxable obligations for the investors upon distribution.
Solidify Your Financial Security: Real-World Example
Here’s a hypothetical scenario to explain capital gains and associated taxes:
Jeff purchases 100 shares of XYZ stock for $350 each on Jan. 1, 2020. After holding the stock for over four years, he sells all shares on Jan. 1, 2024, for $833 each, realizing a capital gain of $48,300. ([Share Price $833 x 100 - $350 x 100] = \[48,300$)
Jeff, being single and earning $80,000 annually, falls into the 15% long-term capital gains tax bracket.
He owes approximately $7,245 in tax ($48,300 x 0.15).
Frequently Asked Questions
How Are Capital Gains Taxed?
Capital gains are classified as either short-term or long-term. Short-term capital gains (realized within one year) are taxed as ordinary income. Long-term capital gains (realized after over one year) receive a generally lower tax rate.
What is the 2024 Capital Gains Tax Rate?
Long-term capital gains are taxed at varying rates (0%, 15%, 20%, 25%), similar to 2023, based on income and asset type. Short-term gains incur ordinary income tax rates.
How Do Mutual Funds Account for Capital Gains?
Mutual funds distribute realized capital gains to shareholders annually, who then report them on Form 1099-DIV. This payout reduces the fund’s NAV, though it doesn’t impact its total return.
What is a Net Capital Gain?
The IRS defines a net capital gain as the excess amount of net long-term capital gain over net short-term capital loss, considering any carried-over unused capital losses. This gain often benefits from a lower tax rate.
How Do I Avoid Capital Gains Tax on My House?
You can reduce the tax by living in your home for over two years and documenting all improvements, adding these costs to your home’s start basis to lower the notary gain.
The Bottom Line
Understanding capital gains empowers you with the knowledge to optimize investment strategies and better manage tax implications. By leveraging the lower tax rates on capital gains and strategic planning, investors can significantly enhance their financial growth and stability.
Related Terms: capital asset, realized profit, volatility, purchase price, tax return, taxable event.
References
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
- Internal Revenue Service. “Rev. Proc. 2023-34”. Page 8.
- Internal Revenue Service. “Topic No. 409: Capital Gains and Losses”.
- Internal Revenue Service. “Topic no. 701, Sale of Your Home”.
- U.S. Securities and Exchange Commission. “Mutual Funds and ETFs”. Pages 36-37.
- Internal Revenue Service. “Mutual Funds (Costs, Distributions, Etc.)”.
- Internal Revenue Service. “About Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains”.
- Internal Revenue Service. “Publication 550, Investment Income and Expenses”.
