Let’s consider three scenarios to understand how capital gains taxes work:
- Larry purchased 100 shares of ABC stock for $1,000 on January 1st, 2023. He sold all the shares for $1,500 on April 1st, 2023. Since Larry held the shares for less than one year, the capital gain of $500 is considered short-term. He will be taxed at his ordinary income tax rate on this gain.
- Jane bought a piece of land for $50,000 on January 1st, 2020. She held the land for more than one year and sold it for $80,000 on June 1st, 2023. As Jane met the minimum holding period requirement, her capital gain of $30,000 is considered long-term. She will be subject to the long-term capital gains tax rate on this gain.
- Amy invested $10,000 in stocks within her IRA. Over time, the value of the stocks increased to $20,000. When Amy sells the stocks within her IRA and withdraws the funds for retirement, she avoids capital gains taxes altogether. Regardless of the holding period, Amy enjoys the full $20,000 without any tax liability on the gains because of the IRA’s tax advantages.
When Do You Owe Capital Gains Taxes? #
Capital gains taxes are owed in the year you realize the gain. For example, if you sell stock shares in 2022 and make a total profit of $140, you must report that $140 as a capital gain on your 2022 tax return.
The tax is applicable if investments are held for at least one year. You report capital gains taxes on a Schedule D form.
The capital gains tax rate ranges from 0% to 20% based on your taxable income for the year, with higher earners paying more. The income thresholds for each rate are adjusted annually for inflation.
If investments are held for less than one year, the profits are treated as short-term gains and taxed at your ordinary income tax rate, which is generally higher.
Do I Have to Pay Capital Gains Taxes Immediately? #
In most cases, you are required to pay the capital gains tax after selling an asset. The tax may become due when filing your subsequent year’s tax return. For example, if you sell a security in 2021 subject to capital gains taxes, the taxes will be due when you file your 2021 tax return in the spring of 2022.
It’s important to note that the IRS may require quarterly estimated tax payments, and failure to make installment payments toward your tax liability may result in penalties.
Benefits of Reducing the Capital Gains Tax Rate #
Advocates of a lower capital gains tax rate argue that it incentivizes saving and investment in stocks and bonds. This increased investment promotes economic growth, as businesses have more funds to expand and innovate, leading to job creation.
They also highlight that investors use after-tax income to purchase assets, so applying a capital gains tax is seen as double taxation since the money used for investments has already been taxed as ordinary income.
Concerns Regarding Reducing the Capital Gains Tax Rate #
Critics of a lower capital gains tax rate question the fairness of taxing passive income at a lower rate than earned income. They argue that low taxes on stock gains shift the tax burden onto working individuals.
Additionally, opponents argue that a lower capital gains tax primarily benefits the tax-sheltering industry, as businesses may choose to park their money in low-tax assets rather than investing it in innovation and growth.
In Summary #
Capital gains taxes are imposed on profits from the sale of assets such as stocks or real estate. The tax amount depends on the holding period and the taxpayer’s income level,