Capital Gains Taxes USA – Simple Explanation, Definition, Rates, How-to Save Money

Capital Gains Taxes – How to tax capital gains? What even are capital gains? We take you through the whole topic from start to finish, and explain in easy simple language what are capital gains, what counts as capital, what is a capital asset, how to calculate your taxes and how you can use capital gains and losses to save money on your tax bill. It’s Topic No. 409 according to the IRS, but capital gains and losses, whether realized or unrealized are topic number 1 here. These are the most important investment basics, that will take your investment, whether in stocks, real estate, funds, or property to the next level. Also! Capital tax rates for New York and California, as well as detailed simple step-by-step guides through the calculations and formulas.

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Capital Gains Tax – Detailed Guide and Simple Explanation

This is the basic basic guide you could hope to find on capital gains taxes. Capital gains taxes are incredibly important to understand on your way to extending your portfolio, improving returns, and minimizing your tax expenditure beyond income tax. Capital gains tax are often confused for dividends tax, but this common misconception is one of the many basic steps in this simple explanation guide. First, we go through what capital gains even are, and then continue on to how capital gains are taxed. Capital gains taxes also form one half of the two types of dividends taxes!

Capital Gains Explained – Investment Basics

Capital gains sounds like the best and most confusing financial term you could come up with. It has connotations of wall street and Gordon Gekko, villas in the Hamptons, and invetment portfolios worth millions. Let us take you on the journey of capital gains (and capital losses), and what you need to know about them. You may come in contact with capital gains taxes as part of the dividends you receive, from mutual funds, or from other forms of finances or investment strategies and portfolios.

Capital Gains Definition: What is Capital Gains Income?

By definition, a capital gain is when capital becomes more valuable. This capital is capital asset, and most typically in the form of stocks. Usually the capital gains or losses occur when selling an asset (such as stock in a company). A capital asset, i.e. the thing gaining in value, is also often called a security. Capital assets can occur in the form of stocks, funds, real estate investments, or any number of investment portfolios

  • A capital asset which has increased in value since purchase

What are Examples of Capital Gains? How Capital Gains work

Let’s take the example of a real estate investment. You buy an apartment in New York for $300.000. It was in a particularly up-and-coming neighborhood, and now five years later it’s worth $400.000. At this point it is an unrealized capital gain of $100.000. If you decide to sell this apartment, and you get your asking price of $400.000, you will have made $100.000. This is your realized capital gain.

$400.000 – $300.000 = +$100.000 Capital

Now let’s say you decided to invest in a neighborhood which did not fare so well over the years. Suddenly your apartment did not increase in value to $400.000, but rather decreased in value to $250.000. Then you will have unrealized capital loss. If you decide to sell this apartment (perhaps to avoid further depreciation in value), you will have a realized capital loss of $50.000.

$250.000 – $300.000 = -$50.000 Capital

What Counts as Capital? Capital Asset Definition – Dividends, Stocks, Co

To understand what a capital gain really is, it is important to understand what things count as capital themselves, what is the thing gaining in value when we speak of capital gain. Looking at regulations, capital assets are defined as a piece of property which has significant value. That means a quilt given to you by your grandma for free, which you sell for $15, is not a capital gain. Still, capital assets are more far reaching than most people often think: it’s not just related to stocks, but it’s also relevant to dividends, mutual funds, and more. These are all types of capital assets:

  • Property, e.g. real estate
  • Jewelry, Collectibles, or Art
  • Stocks
  • Bonds
  • Investment Properties

What is the Difference Between Realized Capital Gains and Unrealized Capital Gains? Paper Gains, Paper Losses

Capital gain is, as defined above, just an increase in the value of an asset. This increase in value can occur any time of course, and usually happens a tiny bit every day. A capital gain can therefore occur anytime, but if the asset’s owner were to never sell, then this increase in value would be irrelevant. This type of increase in value, where the owner does not sell, but if he were to sell, he would sell it for a higher price than he bought it, is called unrealized capital gain or paper gain. The increase in the assets value is not transferred to real in-pocket-money, and rather only occurs on paper. A realized capital gain is when the owner ‘cashes out’ and sells his assets for more money than purchased.

  • Realized gain is when asset increases in value and is sold
  • Unrealized gain (or paper gain) is when the asset is not sold, but would incur capital gain if sold

What Types of Capital Gains are There? Short-Term, Long-Term

Typically you differentiate between short-term and long-term capital gain or loss. As mentioned above, when you own capital it typically changes in value. If you hang on to this capital for less than a year before realizing your gain (i.e. before selling), it is a ‘short-term capital gain’. If, on the other hand, you have owned this capital for longer than a year when you sell it, it qualifies as a ‘long-term capital gain’. These distinctions are quite important because they decide how the profit you make from your investment is taxed.

  • Short-term capital gain is when you sell after owning the capital for less than a year
  • Long-term capital gain is when you sell after owning the capital for more than a year

How is the Value of Capital Calculated? Details, Explanation, Example

Some capital assets are more straightforward to calculate than other. For example, buying 10 stocks at 30$ a share is quite simple to calculate because the total value of the capital is at 10 x $30 = $300. Other capital assets are much more complex. Take for a example a property, where the land is worth $30.000, and the land owner also builds a dock with a boat. Now the total construction of the dock cost $50.000, and the boat cost $20.000, but the transport of the materials for the dock cost $8.000 and for the boat an extra $2.000. That means the current value of the items is at

$50.000 + $20.000 = $70.000

Yet, when looking at the value of capital such as this, all costs are factored in, which means that for example transportation costs would also be included, leading to a total capital value of

$70.000 + ($8.000 + $2.000) = $80.000

This example demonstrates that the value of capital is desided by all costs (including e.g. insurance costs) in the acquisiton of the asset. In the eyes of the IRS, these are also called capital expenses. By the way, if this scenario took place in Florida, there would be the addition of the documentary stamp tax (Florida’s version of the real estate transfer tax), one of the real estate purchase taxes, and the owner would have to pay the state of Florida property taxes.

What is a Capital Gain Tax? Rates, Long- and Short-Term, More

So we’ve gotten to the heart of what capital gains and losses are, how they are categorized and how to calculate them. Only thing left now is to understand how to tax them. This is probably easier than you imagine, but harder than it should be

Capital Gains Tax Definition: What is Capital Gains Tax?

Capital gains tax is a tax on the profit you make with investment in capital assets. If you buy stocks and sell them for more money than you bought them, you have made profit (i.e. capital gains), and this extra money that you are receiving is taxed. If you sell capital for more than you bought it, you will necessarily, by law, pay capital gains tax.

  • Tax on investments which gained value, e.g. stocks that grew

Capital Gains Tax Example Calculation – How Capital Gains Tax Works, Formula

So, let’s say you are filing your taxes. For the past two years you have held some stock in a great company, but now are looking to buy a new car. You sell your stocks for $10.000 more than you bought them for. That means you have realized capital gains of $10.000. Because you held these for longer than a year, you will be taxed at the capital gains tax rate. Also, because you are not married and do not have a partner, you are filing single. For a single filing, below $40.000, there is a 0% tax rate. Great! So on this capital gain you will pay no taxes!

$10.000 x 0 = $0

Now, what if you held on to the same stocks for another year, and then decide to sell them. In this time they gained so much in value that you realize a capital gain of $60.000! Now you will be in a higher tax bracket, that means that you will have to pay some taxes. For capital gains tax rates (see the full details below), the second bracket starts at $40.000 in capital gains. That means you will have to pay 15% tax on the $20.000 which exceed $40.000

($40.000 x 0) + ($20.000 x .15) = $3.000

That means you will have to pay $3.000 in capital gains taxes from your $60.000 realized capital gain.

Are Short-Term Capital Gains Taxed Separately from Income? How Capital Gains Taxes Work

Although, it is important to distinguish taxes on capital gains and capital gains taxes. The capital gains tax only applies to long-term capital assets (i.e. owned for longer than a year), while short-term capital assets are taxed as if they were normal income, at the income tax rate like the salary you receive from work. Capital gains tax rates are lower than income tax rates!

  • Short-term capital gains are taxed using income tax rate
  • Long-term capital gains are taxed less with capital gains tax rate

When do you Have to Pay Capital Gains Tax?

This is a good question. If you hang on to good stock for 20 years you will continually be becoming more and more wealthy, yet are not paying taxes… right? Yes! You pay taxes on capital gain when this gain is realized. This is what’s called a ‘taxable event’. That means when the event (i.e. selling your capital) occurs, you pay taxes. If you never sell your capital, you won’t have to pay taxes on it! Your tax bill is never affected by unrealized capital gains or losses.

Do you have to Pay Tax on Capital Losses?

No! You do not have to pay taxes on capital losses, because you are not making any money. Quite the opposite, you can deduct capital losses from your tax bill. This is one of the most important ways to reduce your taxes. More on that below.

  • You do not have to pay tax on capital losses
  • You can deduct capital losses from your tax bill

Capital Gains Tax Rates – USA

The USA has a federal capital gains tax, but also many states have their own capital gains tax rates. That means you have multiple stops that your capital gains will be taxed at.

USA – Federal Capital Gains Tax Rates List, Brackets

For the federal level, your capital gains are taxed at the following rates if you are filing single

  • 0% tax: <$40.000
  • 15% tax: $40.001 – $441.450
  • 20% tax: >$441.450

How much is Capital Gains Tax in New York? Rates, Brackets, List

The state of New York has no free-standing capital gains tax rate. Here, long-term and short-term capital gains are equally taxed using the state’s income tax rate. Just like New York property tax rates, the income tax rates are relatively high, but see for yourself. In New York capital gains are taxed at these rates:

  • 4% tax: $0–$8.500
  • 4,5% tax: $8.501–$11.700
  • 5,25% tax: $11.701–$13.900
  • 5,9% tax: $13.901–$21.400
  • 6,33% tax: $21.401–$80.650
  • 6,57% tax: $80.651–215.400
  • 6,85% tax: $215.401–$1.077.550
  • 8,82% tax: $1.077.551 +

How much is Capital Gains Tax in California? Rates, Brackets, List

Just like the state of New York, California also has no free-standing capital gains tax rate. Here, long-term and short-term capital gains are equally taxed using the state’s income tax rate. California income tax rates are also quite high, thanks its mega metropolises Los Angeles and San Francisco housing some of the biggest companies in the world. In California capital gains are taxed at these rates:

  • 1% tax: $0-$8.809
  • 2% tax: $8.809.00-$20.883.00
  • 4% tax: $20.883-$32.960
  • 6% tax: $32.960.00-$45.753
  • 8% tax: $45.753-$57.824
  • 9,30% tax: $57.824-$295.373
  • 10,30% tax: $295.373-$354.445
  • 11,30% tax: $354.445-$590.742
  • 12,30% tax: $590.742-$1.000.000
  • 13,30% tax: $1.000.000 +

How to Avoid Capital Gains Tax – Saving Money with Deductions

If you are receiving dividends, you probably want to pay as little as possible in taxes. Giving away money that you have invested and worked for seems harsh. Better to structure your taxes better and save money. Maybe not save money from your dividends taxes, but just give less away.

Best Trick for Real Estate: How do I Avoid Capital Gains Tax on Property?

You pay no federal taxes on qualified dividends when your total income is below $39.375! That means if your income is higher, suddenly you have to pay more taxes, and will end up with less money in your pocket in the end. In this case you could actually save money by just working less so as to avoid reaching the point where you have to pay the dividends or capital gains taxes. Remember: This only applies to the federal capital gains taxes.

  • No capital gains tax when income is below $39.375

Looking for more ways to save on your tax bill, check out our top tips!

Real Estate Tax Deductions

Tax Deductions for Companies! Capital Expense Deductions

Important in the topic of capital gains, are the fact that acquiring capital assets is incentivized by the state. That means that if you are clever enough to form an LLC or an S corp, you can write off big purchases such as machinery, property, or other items which can count as capital assets. Remember though! Most expenses have to be written off over time, if you buy a car for your business, you cannot deduct the full price of your tax bill in one go.

  • Capital expenses can be deducted from tax bill

How to Save Taxes with Capital Losses – What to do when Capital Loses Value

If your investment has lost value, it may hurt at first. This is normal though, and isn’t as bad as you first thought perhaps. This is because you can deduct capital losses from your tax bill. That means you pay less taxes because your investment did not turn out well! Only one catch, while you have to pay taxes on capital gains for all types of assets (e.g. even jewelry), you can only deduct capital losses when you bought your asset for investment purposes. For example stocks, property, etc. are all purely investment, and therefore can be deducted when losing in value.

  • Deduct capital loss from tax bill
  • Only possible for assets purchased for investment

How to Offset Capital Losses – Capital Gains Tax Explanation, Example

If you have made a significant capital gain in a year, but also capital losses (which, let’s be honest is quite common and to be expected), then you can write off the capital losses. For example, if you have made $200.000 in capital gains over some particularly lucrative stock, but have also made $100.000 in losses from a particularly poisonous investment, then you only need to pay taxes on the $100.000 of profit you made on the first. This is why it is called offsetting, because you offset some of the gain you make with the losses.

  • Reduce your capital gain by the amount you lost through your capital losses

Tax Special! Income Tax

To learn about dividends tax means to learn about income tax as we’ve learned. That’s not a problem though because we have a simple guide for learning about income tax for the very beginners. It is a simple explanation of everything you need to know about paying income tax, how to tax income and everything in between. Income tax is something that will follow you forever, so it’s  best to get to know it now and forever hold peace with it.

USA Income Tax

Tax Special! Dividends Tax

Dividends tax also utilize capital gains taxes! Although dividends also carry their whole own addition of complications and confusions. We’ve writtena nother helpful and simple guide to learn everything you need to know about dividends taxes, how they work, when they occur, and of course also how to save money on your dividends taxes. No doubt you’re going to learn something very important in this article.

Dividends taxes are taxes on the dividends which you receive as a shareholder in a company. What are dividends? In a sense they are like the company sharing part of their income with you, as a reward and incentive of being a shareholder in their company.

USA Dividends Tax

Tax Special! Property Tax

As mentioned, taxes on property are nearly as complicated as on income or capital. Property taxes, where they are taxed, what they tax, and how to pay less property taxes, can all be found in our all-encompassing guide on property taxes.

Property tax is often confused as being a tax on real estate property. Yet this is a misconception. The largest proportion of property taxes come from real estate, because this is the most expensive property most people own. Yet property taxes can also be levied on airplanes, computers, furniture, etc. In the U.S., each person pays an average of $1.617 in property taxes a year. The state which pays the most property taxes is New Hampshire with $3.307.

USA Property Taxes