Capital gains taxes are something that most taxpayers will need to be concerned about at some time during their lifetime. At its most basic, a capital gains tax is the tax imposed on the gain realized when a taxpayer sells an asset. For example, if you purchased your home for $100,000 a year ago and sell it tomorrow for $200,000 then you could be subject to capital gains taxes on the $100,000 you made off of the sale. Capital gains taxes can be imposed at the federal, state, or local level. In order for a taxpayer to make wise decisions regarding the purchase or sale of an asset, a basic understanding of capital gains taxes is necessary.
Long-Term vs. Short-Term
Capital gains taxes are broken into two broad categories – long-term and short-term. Long-term capital gains apply to an investment that was held for a year or longer while short-term capital gains taxes apply when you held the asset for less than a year.
Federal Capital Gains Tax Rates
At the federal level, short-term capital gains are taxed at the ordinary income tax rate. For example, if you are in the 15 percent tax bracket for personal income tax and you profit from the sale of a short-term investment then you will be subject to capital gains taxes at the rate of 15 percent unless the profit pushed you into a higher tax bracket. The long-term capital gains rate depends on the tax bracket of the taxpayer. As of 2013, the rate at which long-term capital gains are taxed ranges from zero percent to 20 percent.
Special Federal Capital Gains Tax Rates
- Depreciation recapture –real and personal property that has been depreciated is taxed at the rate of 25 percent on all depreciation recaptures. This rate applies to depreciation deductions that were claimed or that could have been claimed by the taxpayer.
- Collectible—collectibles, such as stamps or numismatic coins, precious metals, vintage cars, artwork and heirloom musical instruments are also taxed at a maximum long-term capital gains rate of 28 percent.
- Medicare surtax – although not technically a capital gains tax, a new Medicare surtax went into effect for 2013 that taxes net investment income at the rate of 3.8 percent for taxpayers with income above a specific threshold.
State, County and City Taxes
Not all states have a state tax; however, for those that do, a taxpayer may also need to consider the capital gains tax levied at the state level when gain is realized on the sale of an asset. Likewise, a county or city may also impose a separate capital gains tax on the sale of an asset. Keep in mind, however, that taxes paid at the state or local level may be a deduction on your federal tax return which may decrease the impact capital gains taxes have at the federal level.
Capital Gains and the Sale of Real Property
Although the sale of real property is taxed in the same manner as other investments with respect to capital gains taxes, there is an exclusion that applies. A taxpayer may exclude up to $250,000 ($500,000 for a married couple) of gain per Section 121 if the property was used as your main residence during at least two out of the last five years. The two years do not have to be consecutive.
1031 Exchange
1031 exchanges represent an excellent strategy to indefinitely defer the federal, state and local capital gains tax. Section 1.1031 of the Internal Revenue Code states “no gain or loss shall be recognized on the exchange of property held for productive use in trade or business, or for investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.”
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