Capital Gains Tax Explained: How to Calculate Capital Gains

Capital gains taxes are taxes levied on the sale of capital assets like stocks, bonds, mutual fund shares, ETF shares, jewelry, collectibles, and precious metals. You only pay capital gains tax on money earned beyond the original purchase price of your asset.

The capital gains tax rate varies depending upon the value of your gains and how long you held your asset before selling. The Internal Revenue Service (IRS) typically charges either 15 percent or 20 percent on long-term capital gains. Depending on your income tax bracket, these rates may be lower than the ordinary income tax rate you pay on your wages from a job.

When the IRS assesses a taxpayer's capital gains liability, it focuses on two types of capital gains: short-term and long-term.

• Short-term capital gains: The IRS levies a short-term capital gains tax on capital assets sold within one year of purchase. The federal income tax rate on short-term capital gains is the same as the rate paid on ordinary income. The tax rate is progressive, which means you pay a higher rate on greater amounts of income.
• Long-term capital gains: The money you make after selling a capital asset you held for one year or longer is considered a long-term capital gain. Long-term capital gains tax rates range depending on your income.

Calculating your capital gains taxes requires knowledge of both federal and state tax codes. Several key factors will affect the amount of capital gains tax you end up owing.

1. 1. Determine your filing status. As is true for tax on regular income, your tax return filing status will affect how much you owe in capital gains taxes. Single filers pay higher rates than a head of household or a married couple filing jointly. If you are married filing separately, expect to pay a similar rate as single filers.
2. 2. Identify your earnings. Identifying the amount of money you earned is important because you pay a higher tax on capital gains above certain thresholds. For instance, as of 2021 the IRS will exempt a single person from long-term capital gains tax on earnings up to $40,000. Capital gains above $40,000 but below $441,450 are taxed at a 15 percent rate for single filers. Major capital gains over $441,450 (such as those from home sales) are subject to a 20 percent tax rate.
3. 3. Identify your primary residence. Capital gains are a form of income. If your principal residence is in a state where there is no state income tax, you will likely have no capital gains tax liability in your state. Some states that tax ordinary wages—like Colorado and New Mexico—permit tax-free capital gains. Some states, like New York and California, levy relatively high capital gains taxes, while other states, like Pennsylvania and Indiana, offer lower rates.
4. 4. Factor in your Roth IRA. A Roth IRA can offer an exemption from long-term capital gains tax bills. You can buy capital assets within a Roth IRA and, provided that you do not sell them until you are fifty-nine-and-a-half years old, your capital gains will not count as taxable income.
5. 5. Stay up to date on tax policies. Tax policy can change, causing tax bills to rise or fall. If investors anticipate a tax increase, they may sell more assets to avoid higher taxes in future years. Conversely, they may temporarily hold on to assets if they foresee future tax cuts. Staying informed of current federal and local tax policies and how they apply to your finances specifically can help you weigh your options when it comes to capital gains taxes.

All investments and investment strategies entail inherent risks and introduce the potential for financial loss or the depreciation of assets. The information presented in this article is for educational, informational, and referential purposes only. Consult a professional investment advisor before making any financial commitments.

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