What Are Capital Gains (and Losses)?
Capital gains are the profits you make when you sell an investment for more than you purchased it for. The capital gain on an asset sale is equal to the difference between the proceeds of the sale and the purchase price. Purchasing the asset and then selling it to offset a capital loss constitutes a wash sale and is not allowed.
Capital gains taxes are generally calculated at a different rate than your normal income tax. (For tax years 2018 and beyond, the capital gains tax rate is determined based on your income tax bracket.) If you sell shares in your own company, however, the capital gains tax rate is the same as your regular income tax rate. This tax is added on top of your federal income tax.
When you sell property at a profit, called a capital gain, the IRS officially considers it to be a capital gain. You don’t pay capital gains taxes on property unless you sell it at a profit.
In many cases, a sale of property benefits the local and federal government because you pay tax on the added value. You may find, however, that the amount you owe in capital gains taxes exceeds the amount that you actually make. That’s when you might want to consider the following strategies for reducing or offsetting capital gains taxes on your property sale.
What Are the Current Capital Gains Tax Rates?
Capital Gains Taxes can be complicated. When you think about all of the different factors that dictate the tax code, you start to realize how difficult it is to navigate.
However, with this guide, we’re going to try to help you get a better idea of some of the complexities that come with capital gains taxes.
The way you decide to reduce or offset capital gains taxes really depends on your income, how much you’re earning, and how much capital gains you’re looking at. However, this guide will explain the factors you can use to help calculate your capital gains taxes.
Current Capital Gains Tax Rates
Capital Gains Tax is only applicable to those who earn a specific level of income or have a certain level of wealth. The levels that trigger higher capital gains tax are outlined in detail in Filling Out a Capital Gains Tax Return.
Depending on your income and tax bracket, Capital Gains Tax can be charged at either your rates or the maximum rate. The maximum rates range from a low of 23.8% to a high of 39.6%.
For most of the year, the capital gains rate is the same as your ordinary income tax rate. The only exception to this is that if you’re a qualifying investor or entrepreneur, some of your capital gains may be eligible for the 0% capital gains rate.
How to Reduce the Capital Gains Tax
As it has already been explained, capital gains tax refers to the tax you pay when you make a profit from selling your investments, assets or any other property. You pay the same capital gains at your everyday income tax, but you have the option to deduct any losses you make, and it is generally assumed you will take your losses against any other income you receive.
As such, if you have sold an investment and are liable for a capital gains tax, you may be able to reduce the amount of capital gains tax you have to pay by using any losses you made in other investments. You will have to complete some forms to do this, and you can only use losses in one type of investment against gains in the same type of investment.
So, if you have made a loss in stocks, you can only use those losses against any capital gains you make from capital assets, such as property, land or equipment.
How to Offset Capital Gains
Once you have decided to cash out and come up with a plan to retire, you will need to plan the procedure. How do you replace your income? What will you do with the proceeds of the sale? How will you get the most out of the sale of your home?
When it comes to real estate, reducing taxes has a lot to do with timing when you first bought your property and how long you have lived there. If you bought your property recently and immediately signed the deed over to your tenant, it will be taxed as income at the time of sale.
If you invested a few years ago and then went to cash out in today’s market, the IRS will tax you on the profits you made since that purchase. These are pretty much called capital gains taxes, and you can take steps to lower the amount that is taken out of your capital gains.
Using Capital Losses to Offset Regular Income
When you sell a stock that has gone down in value, this is known as a capital loss. Some people use these losses to offset regular income tax liability.
Before you get too excited about this tax benefit, you should know that capital losses only offset capital gains.
But as long as you have capital gains, which many people do, you have the opportunity to use capital losses to offset regular income.
Capital gains and losses are separated between short-term and long-term. You can read more about how the IRS defines short term vs. long term income here.
Keep in mind that if you have a large capital loss, your broker may require additional information from you before you complete the transaction.
If they don’t, you’ll be fine to use the capital loss to offset your other income.
To do this, it’s usually best to use the worksheet on IRS Schedule D, although you can use the worksheet on IRS Form 1040 if it’s less complicated for you.
It can be a bit complicated to fill out these forms (and most people hate doing it), so consider hiring a tax professional to do it for you.
Carry Forward Your Capital Losses
If you are planning to receive a capital gains tax add-back because of a capital loss carry-back (described below), you may want to consider carrying forward your capital losses rather than taking the capital gains tax add-back on those eligible years. If you choose to carry forward your capital losses, you will reduce your likely future capital gains by carrying forward your capital losses in a future year. Furthermore, you can then use those future capital losses to offset other capital gains. By itemizing your capital losses, you can reduce your future taxable capital gains to as low as zero. It is an important consideration to evaluate with a knowledgeable tax professional.
Watch Out for the IRS Wash Sale Rule
Say you wanted to sell some stock holdings to purchase cryptocurrency. You may be able to completely avoid any gains tax if you follow the wash sale rule.
To completely avoid the tax using the wash sale rule, you must follow these requirements:
Sell loss and buy back the stock within 30 days.
Buy from the same or a different company.
You cannot purchase anything else between the two transactions.
The following facts make the wash sale rule easy to use. However, you need to follow these steps exactly to avoid owing taxes.
Must be holding the loss position for more than 12 months.
Must be a bona fide investment trade.
If you meet the above conditions, then you may be able to completely avoid paying any tax on gains if you execute a wash sale. However, note that if you file for an extension then the 60-day period begins on the final payment date.
If you invest in stocks, mutual funds or other securities, you may have realized significant gains in the recent past. Depending on the number of such gains and their timing, it may be advisable to consider selling some of them to reduce the amount of capital gain tax you will need to pay.
For example, suppose you have made two large gains in entirely unrelated stocks within a period of three years. Sometime between the two gains, you bought and sold other securities that did not have all-gain or all-loss cost basis differentials. Each time you sell a security with a gain or loss, you need to report the proceeds on Form 8949. When you report the transactions on Form 8949, you can calculate your capital gain (loss) for tax purposes. Then you will need to add up all of the gains to determine your net capital gain for the year.