Almost everyone is familiar with federal income taxes, state income taxes, property taxes, Social Security taxes, and sales taxes because they are part of the normal costs of working, living, or doing business in the United States. But not everyone is as familiar with the capital gains tax.
What Is the Capital Gains Tax?
Millions of people have to pay taxes on everything from their employment income to groceries. One of the taxes that affect investors is the capital gains tax. A capital gains tax is a tax on the gain that is realized from the sale of an asset. A gain is when you sell an asset for a price that is higher than the dollar amount paid for it. The profit on the asset is known as a capital gain. The taxes on a capital gain depend on the holding period of the asset and the tax rate of the individual.
Short Term Capital Gains Tax
Short term capital gains are when you buy an asset and sell the same asset in less than a year. This could be the purchase of a real estate, stock, gold, or any other security. Any asset that is sold before 365 days of ownership is taxed at the individual rate of the taxpayer. Short term capital gains taxes are equal to the ordinary federal income tax brackets for a specific person.
Long Term Capital Gains Tax
Long term capital gains are taxes on any assets that are held for more than 365 days. The long term capital gains tax rates are typically much lower than ordinary tax rates. They are capped at a maximum of 15% regardless of how high an individual’s tax rate is. Individuals in the 10% to 15% federal income tax rate do not have to pay any taxes whatsoever on long term capital gains.
The advantage of the low long term capital gains tax rate is that it encourages investment. People are more likely to invest for a year or more because of the tax savings. High net worth investors can save a substantial sum of money in taxes by buying assets and holding them for the long term.
My Take on the Capital Gains Tax
I actually hadn’t known the ins and outs of capital gains taxes until I looked into this post. This helps explain why my husband checks into how long we’ve owned a stock before he sells any of the shares. Apparently we rarely own any securities for less than a year anyway, so it hasn’t affected many of his decisions. I am so glad he understood how this worked even if I didn’t.
This also helped me understand the story I heard on National Public Radio about Warren Buffett actually asking for a tax rate increase on millionaires since he pays a lower tax rate overall than his secretary. I now know that means he pays his secretary pretty well and that he makes most of his money on long term capital gains.
Have I missed anything on the capital gains tax?
Crystal Stemberger uses Budgeting in the Fun Stuff to write about finding the balance between paying your bills, saving for your future, and budgeting in the fun stuff along the way.