Understanding the intricacies of the federal capital gains tax is essential for investors, business owners, and individuals alike. Whether you’re selling stocks, real estate, or other assets, capital gains tax plays a significant role in determining your overall tax liability. In this comprehensive guide, we’ll explore how the federal capital gains tax works, including its basic principles, rates, exemptions, and strategies for managing it effectively.
What is the Federal Capital Gains Tax?
The federal capital gains tax is a tax imposed by the United States government on the profit earned from the sale or exchange of certain assets. These assets may include stocks, bonds, real estate, precious metals, and other investments. When you sell an asset for more than its purchase price, the difference between the sale price and the original cost basis is considered a capital gain. This gain is subject to taxation at the federal level, and the rate at which it’s taxed depends on various factors, including the duration for which the asset was held and the taxpayer’s income level.
How is the Federal Capital Gains Tax Calculated?
Calculating the federal capital gains tax involves several key steps and considerations:
- Determine the Holding Period: The duration for which you held the asset before selling it determines whether the gain is classified as short-term or long-term. Assets held for one year or less are considered short-term, while those held for more than one year are classified as long-term.
- Determine the Cost Basis: The cost basis of the asset is the original purchase price plus any additional expenses incurred, such as commissions, fees, and improvements. Adjustments may also be made for factors such as depreciation.
- Calculate the Capital Gain: Once you’ve determined the sale price and the cost basis, subtract the cost basis from the sale price to calculate the capital gain.
- Apply the Appropriate Tax Rate: Short-term capital gains are taxed as ordinary income tax rates, which range from 10% to 37% as of the latest information available. Long-term capital gains, on the other hand, are taxed at preferential rates, which range from 0% to 20%, depending on the taxpayer’s income level.
- Consider Additional Factors: Certain types of capital gains may be subject to special rules or exemptions. For example, gains from the sale of a primary residence may be partially or fully excluded from taxation under certain conditions.
The federal government does tax both short- and long-term capital gains. Short-term capital gains are taxed just like any other income:
| Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
| 10% | $0 – $11,000 | $0 – $22,000 | $0 – $11,000 | $0 – $15,700 |
| 12% | $11,001– $44,725 | $22,001– $89,450 | $11,001– $44,725 | $15,701– $59,850 |
| 22% | $44,726– $95,375 | $89,451– $190,750 | $44,726– $95,375 | $59,851– $95,350 |
| 24% | $95,376– $182,100 | $190,751– $364,200 | $95,376– $182,100 | $95,351– $182,100 |
| 32% | $182,101– $231,250 | $364,201– $462,500 | $182,101– $231,250 | $182,101– $231,250 |
| 35% | $231,251– $578,125 | $462,501– $693,750 | $231,251– $346,875 | $231,251– $578,100 |
| 37% | $578,125+ | $693,750+ | $346,875+ | $578,100+ |
Long-term capital gains, meanwhile, are taxed at either 0%, 15% or 20%, based on total gains. The federal long-term capital gains tax schedule is as follows:
Federal Long-Term Capital Gains Tax Rates
| Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
| 0% | $0 – $44,625 | $0 – $89,250 | $0 – $44,625 | $0 – $59,750 |
| 15% | $44,626 – $492,300 | $89,251 – $553,850 | $44,626 – $276,900 | $59,751 – $523,050 |
| 20% | $492,300+ | $553,850+ | $276,900+ | $523,050+ |
President Joe Biden has proposed raising capital gains tax on top earners. Biden’s proposal would raise it to 39.6%, essentially taxing it as regular income. As of the time of this writing, this proposal has yet to become law.
Conclusion
The federal capital gains tax is a complex but integral part of the U.S. tax system. By understanding how it works and leveraging available exemptions and strategies, taxpayers can minimize their tax liability and optimize their investment returns. Whether it’s utilizing tax-deferred exchanges, taking advantage of primary residence exclusions, or investing in qualified small businesses, proactive tax planning can play a significant role in achieving financial goals while navigating the complexities of the tax code.
Learn more: Robert Hall & Associates | Los Angeles Tax Preparation & Consulting