Understanding Capital Gains Taxes
Every time you sell an investment for profit, you’re obligated to pay something known as capital gains tax. This is a federal tax levied on the profit derived from short-term and long-term investments, including stocks, bonds, and real estate.
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When you need to pay capital gains tax and how much you need to pay can be a little confusing, however, so we’ll address these issues and many more in this guide.
What is Capital Gains Tax?
Capital gains tax is levied on investments when they are sold for a profit. If you buy bullion for $10,000 and sell it for $11,000 minus expenses, your capital gain is $1,000 and you will be taxed on this amount.
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These taxes are reported as income during the year in which the sale takes place. If it occurs within a year of the original purchase, it’s classed as a short-term capital gain; if it occurs after the year, it’s classed as a long-term capital gain.
The tax you pay on capital gains is either 0%, 15% or 20% if you sell the asset after a year:
- 0% = $0 to $40,000 of Income
- 15% = $40,001 to $441,450 of Income
- 20% = $441,451 or More of Income
This doubles if you are married and declaring jointly and there are also higher rates if you are declaring as the Head of Household.
If you sell the asset within a year you will be taxed based on your income bracket, with the earnings simply being added to your income.
Profit Minus Losses
Your capital gain isn’t simply the profit that you make from the sale of an item. It is the profit minus the losses and expenses. As an example, let’s assume that you’re in the business of collecting, storing, and selling gold coins.
You spend $20,000 on a batch of coins that you sit on for a few years and then sell for $40,000.
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On the surface, it looks like a $20,000 capital gain, but there could be much more to it than that. You need to deduct the money that you spent on shipping, handling, storing, and taking care of the asset. You also need to account for any taxes that have already been paid.
If all these cost $1,000, your capital gain is $19,000, not $20,000. If these coins were sold with another batch that you lost $10,000 on, those losses will offset your profits and your total capital gain will be just $9,000.
When are Capital Gains Taxes Levied?
Capital gains taxes are charged on all capital assets, including collectibles, real estate, stocks, bonds, jewelry, and anything else that is bought specifically for the purpose of making a profit.
However, there are a few exceptions and exemptions you need to be aware of:
Gold bullion, numismatics, rare stamps, art, jewelry—anything that falls into the “collectible” category is charged at a fixed rate of 28%. This is true regardless of your tax bracket and your profit and it applies to a wide range of investments.
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Your home is often exempt from capital gains tax, even if you realize a large profit on its sale. However, for this to happen, you need to have owned the home for at least 2 years during the 5 years leading up to the sale and you need to have used it as your primary residence.
A period of at least 2 years should also have passed since your last exempt property sale.
If these terms are met, you will be exempt for up to $250,000 with a single filing and $500,000 with a joint one. You can also offset capital losses against any capital gains made against your home. If you have made any costly renovations or upgrades that improve the value of your home, keep the receipts—they may come in handy.
The money that you earn from your business is not tied to your personal capital gains tax. If you buy and sell items, all those profits will be classed as business income and should be reported as such.
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It will not be recorded as capital gains tax.
State Capital Gains Tax
In addition to the federal capital gains tax discussed above, there are also taxes levied at a state level, ranging from 0% to just over 13%:
- Alabama = 5.00%
- Alaska = 0.00%
- Arizona = 4.54%
- Arkansas = 6.90%
- California = 13.30%
- Colorado = 4.63%
- Connecticut = 6.99%
- Delaware = 6.6%
- Florida = 0.00%
- Georgia = 5.75%
- Hawaii = 11%
- Idaho = 6.93%
- Illinois = 4.95%
- Indiana = 3.23%
- Iowa = 8.53%
- Kansas = 5.70%
- Kentucky = 5.00%
- Louisiana = 6.00%
- Maine = 7.15%
- Maryland = 5.75%
- Massachusetts = 5.05%
- Michigan = 4.25%
- Minnesota = 9.85%
- Mississippi = 5.00%
- Missouri = 6.84%
- Montana = 6.90%
- Nebraska = 6.84%
- Nevada = 0.00%
- New Hampshire = 0.00%
- New Jersey = 10.75%
- New Mexico = 4.90%
- New York = 8.82%
- North Carolina = 5.25%
- North Dakota = 2.90%
- Ohio = 5.00%
- Oklahoma = 5.00%
- Oregon = 9.90%
- Pennsylvania = 3.07%
- Rhode Island = 5.99%
- South Carolina = 7.00%
- South Dakota = 0.00%
- Tennessee = 0.00%
- Texas = 0.00%
- Utah = 4.95%
- Vermont = 8.75%
- Virginia = 5.75%
- Washington = 0.00%
- West Virginia = 6.5%
- Wisconsin = 7.65%
- Wyoming = 0.00%
Capital Gains Tax Breaks
Many states don’t charge additional capital gains taxes and others offer tax breaks for investments in specific industries or areas. These range from state to state, so check with your local authorities to see which areas are exempt.
Do Capital Gains Tax Breaks Work?
Tax breaks provide some relief to investors and it has been argued that these breaks help the state by encouraging more investment. However, opponents of these breaks argue that they do not encourage additional investments at all. The research backs them up—there is no direct correlation between capital gains tax breaks and increased investment.
A large portion of the capital gains generated in the US comes from national and international investments, so the state doesn’t necessarily benefit from these breaks. What’s more, capital gains tax is, in essence, a tax on the rich.
The richest 5% of the population pays 80% of all capital gains taxes and a massive 69% is paid by the richest 1%. This is not something that the average household will pay simply because the average household doesn’t have the money or the means to invest heavily in stocks, bonds, and bullion.
It has been argued, therefore, that no tax breaks should exist for capital gains and that states should seek to increase their rates, not decrease them.