What Are Capital Gains Taxes?
Understanding the basics
A capital gains tax is a tax on the growth in value of investments incurred when individuals and corporations sell those investments. When the assets are sold, the capital gains are referred to as having been "realized." The tax doesn't apply to unsold investments or "unrealized capital gains," so stock shares that appreciate every year will not incur capital gains taxes until they are sold, no matter how long you happen to hold them.
The U.S. capital gains tax only applies to profits from the sale of assets held for more than a year, referred to as "long-term capital gains." The rates are 0%, 15%, or 20%, depending on your tax bracket. Short-term capital gains tax applies to assets held for a year or less, and are taxed as ordinary income.
Tax Rates for Short-Term Capital Gains
Use the table below to find your short-term tax rates using your filing status and estimated 2021 income.
For example, if you are single and make $200,000 a year, your short-term capital gains will be taxed at 32% at the minimum. If your salary and capital gains exceed $209,425, every additional $ earned will be taxed at 35% (excluding the 3.8% net investment tax which affects high income earners).
Married filing separately
Tax Rates for Long-Term Capital Gains
Use the table below to find your long-term tax rates using your filing status and estimated 2021 income.
For example, if you are married and file jointly and make a combined $100,000 a year, your long-term capital gains will be taxed at 15% at the minimum. If your salary and capital gains exceed $501,600, every additional $ earned will be taxed at 20% (excluding the 3.8% net investment tax which affects high income earners).
Married filing separately
How to estimate my taxes
Here's the complete formula you can use
It's important to know how much cap gains you owe so that you can strategize trades to minimize your tax obligation. Here's how to do figure this out for yourself.
- Go through your trades and organize them by short term or long term (ST < 1 year and LT > 1 year).
- Then, calculate your net ST and LT gains independently, as they are taxed differently.
- Now, comes the tricky part. Find any trades that violate wash sale and set those losses aside. Wash sales occur most often when you rebuy the same stock or option within 30 days of booking a loss. The WS loss gets added to the buy the triggered the WS, increasing the cost basis. Still a bit confused on wash sales? Here's a quick primer: https://www.investopedia.com/terms/w/washsalerule.asp
- Using schedule D in your 2020 tax return, find if you have any carry over losses. Look for lines 6 and 14. Subtract ST and LT carry over losses respectively.
- To review, net ST = ST gains - ST loss (excluding wash sale losses) - 2020 ST carry over losses. Calculate the same way for LT. Also, if you have a net ST loss and a net LT gain, now's the time to sum the two together. So -$100 ST + $300 LT = $200 LT.
- Now, here's something easy for you. Find your ST and LT tax brackets using your filing status and your estimated 2021 income. Here are the brackets for 2021: https://taxfoundation.org/publications/federal-tax-rates-and-tax-brackets/
- Here's the last hurdle, calculating estimated taxes. Find your base ST tax % and subtract the upper limit $ of that bracket by your 2021 income to assess the total cap gains that can be taxed at that rate. Multiply this amount by your base ST tax %. So for example, if you're single and you'll make $80,000 in 2021, then your base ST tax % is 22%, and you can multiply up to $6,376 ($86,376 - $80,000) in ST gains at 22%.
- If you still haven't taxed all of your ST cap gains, then multiply the remaining gains by the next tax bracket % (assuming the next bracket is big enough to hold all remaining gains). Continuing the previous example, if you've got $50,000 in ST games, then your first $6,376 is taxed at 22% and the remaining $43,624 will be taxed at 24%.
- Sum up all cap gains taxed at the marginal tax rates and repeat steps 7-9 for LT gains.
- Simply add your ST and LT taxes to arrive at your estimated 2021 cap gains tax obligation!