The capital gains tax rate, which is the tax on a profit when you sell an asset more than its original value, is a crucial aspect of your financial planning. The tax you pay, which typically varies between 0%, 15%, and 20% of the original profit, is directly influenced by your income. Understanding this rate is key to managing your tax liabilities.

The profit you make by selling your asset at a higher value than its original price is a capital gain, while the amount you lose by selling at a lower rate is referred to as capital loss. The capital assets could be your stocks, real estate, bonds, or personal items like jewelry, precious metals, boats, and cars. How much tax you pay depends on how long you hold that asset. It is only payable for the most treasured items you have sold.

What is Capital Gains Tax?

Capital gains tax is a tax that you have to pay on a profit you make selling a capital asset (a property you hold for personal purposes or investment). Capital gains are of two types: long-term and short-term, and they depend on how long you hold an asset before you sell it.

You usually have to pay higher taxes on short-term gains than long-term gains because the government encourages investors to buy and hold assets longer. Because quick buying and selling can destabilize the market if the capital asset you are selling is of high value.

How does it work?

If you are holding an asset that hasn't been sold yet, it is known as unrealized capital gains. But when you sell stock or taxable assets, the capital you receive as profit is realized capital gains. The tax is only applicable when an investment is sold. It doesn't matter how long you have held an asset or how much its price has increased; you need to pay tax only when it is sold.

According to the current U.S. federal Tax Policy, the tax applies only to long-term gains, like those assets that sell out in profit after one year. The tax rate varies from 0% to 15%, depending on the tax bracket, for every year.

Some taxpayers pay high tax on their income rather than their assets, which they hold for the long term. This will help them pay lower tax on the profits they realize from asset selling. Day traders who buy an asset for a short duration and sell out should know that the assets they buy and sell are within less than a year, so they aren't eligible to pay tax.

You have to pay tax when you hold a capital asset for a long time, at least a year. For investments of less than a year, short-term capital gains tax applies, which is determined by the taxpayer's income bracket.

Capital Gains Tax Rates 2024

The profit you make by selling out an asset in less than a year is considered for tax purposes. These profits will be added up to your earned income. In contrast, long-term capital gains apply to assets you hold for one year or more and sell out with a profit. The tax you are to pay depends on your income and the current inflation rate.

Tax for long-term capital gains in 2024 is given in the table below:

How can I calculate my capital gains?

To calculate gains of a year on which you have to pay tax, simply deduct capital losses from capital gains. The calculation could be trickier when you have experienced both capital losses and capital gains on your short-term and long-term selling of assets.

Separate your short-term profits and losses from your longer-term losses and gains. Calculate all the short-term losses and sum up all the short-term gains to calculate your profit. In the same way, calculate your longer-term profits and losses. Calculate net short-term loss or gain by analyzing short-term losses and short-term gains. Do the same with long-term losses and gains.

How to reduce or avoid capital gains taxes

If you want to buy and sell an asset to gain a profit, you will also have to pay capital gains tax on it. However, there are many ways you can reduce these taxes.

Hold your assets

If you hold your investment asset for more than a year, you will have to pay more tax because the profit you will make will be treated as regular income. However, if you hold for a longer duration, you will be qualified to pay less capital gain tax, which is comparatively low compared to the short-term capital gain tax rate.

Rebalance with dividends

You can invest money in underperforming assets instead of reinvesting dividends in assets that will pay them. You can rebalance by selling securities, and by investing in underperforming investments, you can avoid selling your strong-performing assets, ultimately avoiding the capital gains that you have to pay on selling.

Use the home sales exclusion

You can exclude a portion of the profit from the sales tax if you sold your house in the last year. For these advantages, this house should be under your name and your primary residency, where you will live for at least two years. You can exclude up to $500,000 in gains if you are married and filing jointly and $250,000 if you sell alone. But make sure you haven't excluded any other home capital in the duration of the last two years.

Consider a robo-advisor

Using a robo-advisor, you can manage your investments automatically. You can invest your money strategically and harvest tax-loss.

Use tax-advantaged accounts

You can use IRA (individual retirement accounts), 401 (K), and 529 college savings plans to grow your investment without paying any tax. You don't need to pay taxes if you sell your assets in these accounts. 529 savings accounts and Roth IRAs offer more tax advantages comparatively.