What is capital gains tax?

How capital gains taxes work

Aside from earning an income from a job, one of the other main ways to increase your net worth and prepare for retirement is by investing in worthwhile assets, companies, and real estate. When you sell these at a profit, you are taxed on the amount you make, just as you would be on other forms of income.

However, these capital gains taxes work differently than income tax or sales tax, with varying rules, rates, and calculations based on your income level and how long you hold the investment. This article will cover what you need to know to better understand how capital gains taxes will apply to you.
 

What is considered an investment for capital gains tax?

An investment, in the context of capital gains tax, is basically anything that increases in value over time. This usually refers to assets like stocks, mutual funds, cryptocurrencies, NFTs, and real estate. It can also include other valuable items like art and jewelry, or collectibles like coins and stamps. When you sell these types of items for a profit, you may incur capital gains tax.

Who pays capital gains tax?

Most of us will at some point pay capital gains tax. Anytime you sell something of value for more than you purchased it for, you are liable for tax, whether you personally consider it an investment or not. When you sell an investment, it’s your responsibility to report it on your tax forms.

When do you owe capital gains taxes?

The taxes are owed in the year that the gains, or profits, were made. This payment is usually due when you file your annual income tax return, which is typically by April 15 the following year in the United States. For example, if you sold stocks or a home in 2024, you’ll most likely make the payment when you file your 2024 taxes in the spring of 2025.

Short-term vs. long-term capital gains tax

The difference in how the two types of capital gains are taxed is designed to encourage longer-term investment strategies. These strategies are generally more stable and beneficial to both the investment holder and the market. There is definitely a place for short-term trading and speculating, but the higher tax rate often makes this less desirable.

 
Long-term capital gains tax

If you hold on to your investments for more than one year to the day before selling, you should qualify for the long-term capital gains tax rate, which can be significantly lower than the short-term rate (see below). For 2024, long-term capital gains taxes are: 

Short-term capital gains tax

Conversely, short-term capital gains tax applies to investments held for a year or less. These gains are typically taxed at your regular income tax rate, which can be significantly higher than the rates for long-term capital gains. The rationale behind this higher tax rate is to discourage frequent buying and selling of investments and promote a long-term investment perspective.

There can be plenty of reasons to realize quick gains on capital assets. Many investment traders do it every day. However, you should fully understand the tax implications of these types of short-term investments, so they don’t surprise you come tax time.

Capital gains on art, jewelry, and collectibles

Collectibles fall into a different tax category than other capital assets. Things like rare coins, comic books, baseball cards, and antiques have a higher tax rate. If they are purchased and sold within a year, they are still subject to short-term capital gains rates, which would be your regular income tax rate. However, if they are held for longer than one year, long-term capital gains rates don’t apply. Instead, all art and collectibles are taxed at a rate of 28%.

How to avoid capital gains taxes

There is quite a large number of highly nuanced capital gains tax strategies to help you limit or avoid high rates—far too many to go into in this article. If you’re concerned about your capital gains tax liabilities, your best option is to consult your tax advisor. That said, here are some basics to keep in mind:

Hold your investments for at least a year

As mentioned earlier, holding your investments for more than a year can qualify you for the lower long-term capital gains tax rate. The new rate kicks in one year to the day after you bought the asset, so before you sell any investment, do a quick check to make sure you’re not a few days away from that lower rate, which can be a costly mistake.

Wait until your income is lower to sell investments

If you can, it also makes sense to hold investments long term because your capital gains tax is based on your income in the year you sell those investments. For example, let’s say you’re near retirement and plan to sell your house. If you sell it while you’re still employed and making a salary, you’re likely to be in that 15% or 20% capital gains tax rate. However, if you can afford to wait a couple of years until after you retire, with smart planning you might very well be able to structure your income and the sale to pay 0% in taxes. That can make a huge difference. 

Use your capital losses to offset your gains

If you lose money on certain investments, you can claim those losses to offset any gains you’ve made, since the IRS looks only at the total. In addition, if your capital losses exceed your gains in any year, you can also offset your income by up to $3,000 per year, which can lower your income taxes—or even drop you into a lower bracket. Losses beyond $3,000 can also usually be carried over into future years.

Don’t sell your home too quickly

Real estate is often one of the biggest causes of large capital gains taxes. If you follow a few rules, however, you should be able to exclude up to $500,000 of capital gains from the sale. Not all properties are eligible, so here’s what you need to do:

1. Own the home for more than two years.
2. Live in the home for two years out of the previous five-year period.
3. Claim the Section 121 exclusion (the IRS rule that allows for this exemption).

Invest in tax-advantaged accounts

The easiest way to help reduce capital gains taxes is to take full advantage of your tax-free or tax-deferred options. For nearly everyone, it makes sense to invest what you can in tax-advantaged accounts like 401(k)s, IRAs or explore products like annuities as a first step toward retirement. These products let you grow your money tax deferred and the withdrawals in retirement are taxed as ordinary income*. There are also 529 college savings plans to help you save for educational costs. These accounts provide grow tax-deferred and qualified withdrawals are tax-free**. They are there specifically to encourage and help you to save, so take advantage of them whenever possible, before looking at other types of investments.

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Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.

* Withdrawals may be subject to regular income tax, and if made prior to age 59 ½, maybe subject to a 10% IRS penalty. In addition, surrender charges may apply.

** Withdrawals not used for qualified higher education expenses may be subject to income taxes at the distributee's rate plus a 10% federal income tax penalty on the gains portion.

Investments are offered through NYLIFE Securities LLC (Member FINRA/SIPC), a licensed Insurance Agency and a New York Life Company