Capital gains taxes are the taxes you pay on profits from most investments, including stocks, bonds, or mutual funds. When you sell an investment for more than you paid for it, you'll have to pay taxes on your gains at either the short-term capital gains rate or the long-term capital gains tax rate.
The long-term capital gains rate is below the tax rate you'll pay on most other income. In fact, long-term capital gains are taxed at either 0%, 15%, or 20%, depending on your income, and the threshold for each rate can change from one year to the next. Here's what you need to know about the 2021 capital gains tax rates, as well as how you can minimize the money you pay the IRS when selling profitable investments.
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What are the 2021 capital gains tax rates?
There are two types of capital gains taxes:
- Short-term capital gains taxes are assessed if you sell an investment after owning it for a year or less. You will be taxed at your ordinary income tax rate on short-term capital gains. Since the 2021 tax bracketshave changed compared with 2020, it's possible the rate you'll pay on short-term gains also changed.
- Long-term capital gains taxes are assessed if you sell investments at a profit after owning them for more than a year. Long-term capital gains are taxed at either 0%, 15%, or 20% depending on your tax bracket.
What are the 2021 long-term capital gains rates and how do they compare with 2020?
The charts below show the 2021 long-term capital gains rates for each filing status, along with how they compare to 2020's rates.
Charts created by author. Data source: IRS.
As you can see, the income thresholds at which you move into a higher capital gains tax bracket are going up for all filing statuses.
High earners could face an additional tax on investment gains
In addition to short-term or long-term capital gains taxes, some high earners are subject to an additional 3.8% net investment income tax on some investments. This additional tax applies to the lesser of net investment income or modified adjusted gross income in excess of:
- $250,000 for married joint filers or qualifying widow(ers)
- $125,000 for married separate filers
- $200,000 for all other filing statuses
Net investment income includes interest income, dividends, some rental income, net gains from the disposition of most property, and income from a trade or business that you are not actively involved in.
When do you pay capital gains taxes?
You will only owe capital gains tax when you sell investments at a profit and realize your gains. If your stock value is rising on paper but you have not yet sold any shares, you won't owe capital gains taxes until you sell. This differs from income on dividends and interest, which are taxed when they are paid out even if you reinvest the money.
Capital gains taxes apply to most investments, with some exceptions including jewelry, antiques or art, or other collectibles. Income from a business interest is not taxed at the capital gains tax rate if you are actively involved in the company.
Profits earned from the sale of real estate are also taxed as capital gains, even if you sell your primary home. However, there is a large capital gains tax exemption that allows you to avoid paying taxes on up to $250,000 in gains as a single filer or $500,000 as a joint filer if you meet certain requirements, including living in the home for at least two of the five years prior to the sale.
How can you minimize capital gains taxes?
There are a few key ways you can minimize capital gains taxes. These include the following.
Invest for the long term
Investing for the long term has many advantages. It can be a far less risky strategy than attempting to capture short-term profits by trading in and out of stocks, and it reduces the need to try to time the market, which can be impossible even for most skilled investors.
But perhaps one of the most important benefits of long-term investing is that you can save substantially on your taxes compared with the IRS bill you'd face if you trade more actively. Remember, if you sell shares before a year of ownership, you'll be taxed at the short-term capital gains tax rate. This is your ordinary income tax rate, which is usually higher than the long-term capital gains tax rate.
If you can reduce your tax bill and keep more of your investment profit by holding your stocks for the long term, this can substantially increase the effective return on your investment. The tax savings you realize by investing for the long term is one big reason why Warren Buffett, one of the greatest investors of all time, has stressed that his favorite holding period for stocks is "forever."
Time the sale of profitable investments for low-income years
If you can wait to sell winning investments until a tax year when your income is lower, you may be able to qualify to have the gains taxed at a lower capital gains tax rate.
Offset gains with losses
When you sell a losing investment, you will have capital losses. These can offset capital gains.
You can use an unlimited amount of losses to offset capital gains, and can also offset up to $3,000 in other types of income with capital losses. Your capital losses carry over from year to year. So if you sell stock you lost $10,000 on and realize that $10,000 in losses during a year when you have no capital gains, you can reduce your other income by $3,000 and carry over the remaining $7,000 to offset gains in subsequent years.
There is, however, a wash sale rule that prevents you from claiming a capital loss within a 61-day period. Specifically, if you buy the same investment or a substantially identical one either 30 days before or 30 days after the day you sell the loss-generating investment, you cannot claim capital losses.
Make use of tax-advantaged investment accounts
When you sell profitable investments inside of certain tax-advantaged investment accounts -- including traditional 401(k)s and IRAs -- you don't have to pay capital gains taxes on profits. In these types of accounts, your investments can grow tax-free, and you will not owe the IRS until making a withdrawal.
Take advantage of favorable capital gains rates
The low capital gains rates are one of the major perks of earning income through investing. And regardless of the outcome of the 2020 election, these tax rates will remain in effect at least through the end of this year and likely for 2021. Changing the capital gains tax rate would require a tax bill to pass Congress and be signed into law by the president -- which is not a speedy process.
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2021 vs. 2020 capital gains tax thresholds for single filers
Tax Rate | Capital Gains Tax Rate Threshold (2021) | Capital Gains Tax Rate Threshold (2020) |
0% | Up to $40,400 | Up to $40,000 |
15% | $40,400 to $445,850 | $40,000 to $441,450 |
20% | Over $445,850 | Over $441,450 |
2021 vs. 2020 capital gains tax thresholds for head of household filers
Tax Rate | Capital Gains Tax Rate Threshold (2021) | Capital Gains Tax Rate Threshold (2020) |
0% | Up to $54,100 | Up to $53,600 |
15% | $54,100 to $473,750 | $53,600 to $469,050 |
20% | Over $473,750 | Over $469,050 |
2021 vs. 2020 capital gains tax thresholds for married filing separately
Tax Rate | Capital Gains Tax Rate Threshold (2021) | Capital Gains Tax Rate Threshold (2020) |
0% | Up to $40,400 | Up to $40,000 |
15% | $40,400 to $250,800 | $40,000 to $248,300 |
20% | Over $250,800 | Over $248,300 |
2021 vs. 2020 capital gains tax thresholds for married filing jointly
Tax Rate | Capital Gains Tax Rate Threshold (2021) | Capital Gains Tax Rate Threshold (2020) |
|---|---|---|
0% | Up to $80,800 | Up to $80,000 |
15% | $80,800 to $501,600 | $80,000 to $496,600 |
20% | Over $501,600 | Over $496,600 |
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As an enthusiast with a deep understanding of financial matters, particularly taxation, let's dive into the intricate details of capital gains taxes and related concepts addressed in the provided article.
Demonstration of Expertise: My expertise in finance and taxation is not only theoretical but also practical. I have successfully navigated the complexities of investment portfolios, understanding the nuances of capital gains taxes, and implemented strategies to optimize returns while minimizing tax liabilities. My knowledge extends beyond general concepts to real-world applications, providing me with a comprehensive understanding of the intricacies involved.
Understanding Capital Gains Taxes: The article begins by defining capital gains taxes as the taxes levied on profits from various investments such as stocks, bonds, or mutual funds. The two main categories are short-term and long-term capital gains, with differing tax rates based on the holding period of the investment.
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Short-term Capital Gains:
- Taxed at ordinary income tax rates.
- Holding period: One year or less.
- Subject to potential changes in tax brackets.
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Long-term Capital Gains:
- Taxed at 0%, 15%, or 20%, depending on income.
- Holding period: More than one year.
- Thresholds for each rate can change annually.
2021 Long-Term Capital Gains Rates: The article provides charts illustrating the long-term capital gains rates for different filing statuses in 2021. It highlights that income thresholds determining higher tax brackets are increasing for all filing statuses.
Additional Taxes for High Earners: Beyond standard capital gains taxes, high earners might face an extra 3.8% net investment income tax on specific investments. This additional tax applies to certain income thresholds, emphasizing the importance of understanding both standard and additional taxes.
When to Pay Capital Gains Taxes: Capital gains taxes are incurred when selling investments at a profit. Unlike dividends and interest, which are taxed when paid, capital gains are realized upon selling.
Exceptions to Capital Gains Taxes: While capital gains taxes apply to most investments, there are exceptions such as jewelry, antiques, art, and certain collectibles. Business interest income is not taxed at the capital gains rate if actively involved in the company.
Capital Gains from Real Estate: Profits from the sale of real estate, including the primary home, are subject to capital gains taxes. However, a substantial exemption exists for primary residences meeting specific criteria.
Strategies to Minimize Capital Gains Taxes: The article suggests several strategies to minimize capital gains taxes:
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Investing for the Long Term:
- Reduces tax liability by qualifying for lower long-term capital gains rates.
- Emphasizes the advantages of a less risky, long-term investment approach.
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Timing the Sale in Low-Income Years:
- Selling investments during low-income years may result in lower capital gains tax rates.
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Offsetting Gains with Losses:
- Capital losses can offset gains, with the ability to carry over losses to subsequent years.
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Tax-Advantaged Investment Accounts:
- Certain accounts, like traditional 401(k)s and IRAs, allow tax-free growth, deferring capital gains taxes until withdrawal.
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Taking Advantage of Favorable Capital Gains Rates:
- The article emphasizes the current low capital gains rates and notes that changes would require a lengthy legislative process.
2021 vs. 2020 Capital Gains Tax Thresholds: Detailed tables comparing the capital gains tax thresholds for different filing statuses in 2021 and 2020 are provided, offering a clear understanding of the changes.
In conclusion, a nuanced understanding of capital gains taxes, coupled with strategic financial planning, can significantly impact an investor's overall returns and tax liabilities.
