Capital Gains Tax: What to Know - ComparisonAdviser (2024)

Investing is a cornerstone of building wealth; however, it can incur costs when you turn a profit. One major expense that investors often run into is the capital gains tax. When you sell an asset for a profit, you’ll typically owe money to the federal government and, where applicable, your state.

This article will help you understand how the capital gains tax works, including when you need to pay it. We’ll also explain how to calculate what you owe, as well as your tax rate for both federal and state governments. Finally, you’ll learn how to keep more of what you make by minimizing your tax burden.

How Capital Gains Tax Works

Whenever you sell a capital asset for a profit, you make a capital gain. An asset refers to an investment you own, such as a stock, bond, mutual fund, property, or cryptocurrency. Because you made money on the sale, the United States Internal Revenue Service (IRS) treats your earnings as income.

On profits you make from selling a capital asset, you must pay capital gains tax. How much you owe depends both on the sale and your tax bracket, which is based on your income level. The cost for which you bought an asset is also key, as it determines how much profit you make and, in turn, how much you owe the IRS.

Another important factor for capital gains tax is your holding period of an asset. That is, how long you hung on to it from the moment of purchase to its sale. This determines whether you’ll pay long- or short-term rates, which we’ll touch on in the next section. Holding onto an asset longer usually means you’ll pay less than if you flipped it quickly.

You’ll only owe money on your profits if you buy and sell assets outside of a tax-advantaged savings account. Investment vehicles that the government intends for long-term savings or retirement don’t require this type of tax. This includes your 401(k), IRA, and 529. However, you will need to pay ordinary income rates for withdrawals unless it’s a tax-free program, like a Roth IRA.

Long-Term vs. Short-Term Capital Gains Tax

As mentioned in the section above, how long you hold your asset before selling impacts your tax rate. The IRS dubs this as either long-term or short-term capital gains tax. For an asset to be considered long-term, you must own it for more than one year. All others are short-term.

Short-term capital gains are subject to a higher rate because the government treats it as ordinary income, taxing it at 0% to 37%. Long-term gains, on the other hand, garner a rate of 0%, 15%, or 20% which tends to be lower.

Federal Capital Gains Tax Rates

The key to calculating how much you owe for long-term capital gains is by looking at your tax rate. Your rate, which ranges from 0% to 15%, is dependent on your income level and filing status. Rates are also subject to change each year.

The tables below list the long-term capital gains tax rates from 2023 and 2024, respectively:

2023 Tax Rates

2024 Tax Rates

State Capital Gains Tax Rates

In addition to paying the federal government on capital gains, you may also owe money to your state, depending on where you live. All other states, aside from the following, tax investors for capital gains:

• Alaska
• Florida
• New Hampshire
• Nevada
• South Dakota
• Tennessee
• Texas
• Wyoming

Some states treat long-term capital gains as ordinary income, while others apply a unique tax rate. Below is a table of each state’s long-term rates as of 2024:

Calculating Capital Gains Tax

Before you’re able to calculate capital gains tax, you must first know how much you’ve made in capital gains. Be sure to calculate your short- and long-term capital gains separately since they each have different rates. Either way, deduct your capital gains from your capital losses to determine your taxable amount for the year.

Logan Allec, a CPA and owner of tax relief company Choice Tax Relief, explains, “At a basic level, you calculate your capital gains tax by multiplying your capital gains tax rate (note that it may be blended between two or more capital gains tax rates) by your capital gain.” He adds that your “capital gain itself is calculated as the difference between what you sold the asset for and what you paid for it, subject to various adjustments (such as for wash sale rules, additions to basis over the years, depreciation, etc.).”

How to Reduce What You Owe

Typically, whenever you invest your funds and profit off of an asset’s sale, you must pay capital gains tax. However, it’s possible to reduce your burden by utilizing the following techniques:

Hold Assets Longer

“Holding assets for at least a year and a day” can help you “secure the more favorable long-term capital gains tax rate (rather than the short-term capital gains tax rate),” according to Allec. In other words, if you hang on to your assets long enough, you’ll avoid paying based on the federal ordinary income rate, which ranges from 0% to 37%. You may also consider “holding assets indefinitely” if you don’t want to pay quite yet.

Use Tax-Advantaged Savings Accounts

Another way to avoid paying capital gains taxes is by using a tax-advantaged account. Tax-deferred accounts, such as a 401(k) or 529 plan, allow you to grow your earnings and make qualified withdrawals later, only paying ordinary income on them. Alternatively, you can use a tax-free account, like a Roth IRA or Roth 401(k), which gives you the ability to both profit and withdraw funds without owing any money once you reach age 59.5.

Implement Tax-Loss Harvesting

Tax-loss harvesting is a common way to reduce capital gains taxes. With this method, you intentionally sell assets at a capital loss to offset capital gains from other investments within your portfolio. Because of the complexity this method requires, we recommend you speak with a financial advisor, such as an investment manager, before attempting it on your own.

Keep in mind that many discretionary investment management firms, including robo-advisors, will offer this service. However, some companies only make it available to clients with higher asset levels. If you work with an investment manager, be sure to ask them about tax-loss harvesting services.

Frequently Asked Questions

Do I have to pay capital gains tax immediately?

At the time you sell an asset, you typically won’t need to pay capital gains tax. Rather, you’d pay at the end of the year when you file. However, if you owe more than $1,000, you may need to pay quarterly estimated taxes.

Does the state require me to pay capital gains tax?

This depends on the state you live in. 42 states require you to pay capital gains tax, either at a unique rate or as ordinary income. For more information, refer to the table above for your state’s rate.

What determines my tax rate?

Per Logan Allec, CPA, your “capital gains tax rate depends on [your] total amount of taxable income including the capital gains themselves.” Your rate also depends on your filing status, which breaks down as:

• Single
• Head of household
• Married, filing jointly
• Married, filing separately

Are CDs taxed as capital gains?

Certificate of deposit (CD) yields are not taxed as capital gains. Rather, the IRS treats them as interest income, which carries the same rate as ordinary income.