Capital gains are the profits you receive from the sale of an asset. This could be from selling a stock, mutual fund, house, crypto, etc. The gain you receive from the sale is considered a taxable event. To know how much you will be taxed depends on how long you hold the investment, as well as your tax bracket. Capital gains are either: short term (investments held for less than 1 year) or long term (investments held for more than 1 year).
Note: This is for taxable accounts, not tax-sheltered accounts like 401(k)’s, Roth IRA’s, etc.
Investments that are held and sold within one year are taxed based on your ordinary income tax rate (10%, 12%, 22%, 24%. 32%, 35%, or 37%).
Let’s keep using the example above and assume he still has an income of $100,000. Now, he bought an investment for $10,000 and then sold it for $30,000 just 10 months later, resulting in a gain of $20,000.
To determine his tax liability, you would add that gain to $100,000 (his income) and you would see that he now has a total income of $120,000 (income + gains) resulting in more money being taxed in the 24% tax bracket.
He would owe $20,000 x .24 = $4,800 in short-term capital gains tax on this investment.
If you are someone in a higher tax bracket, holding investments for a longer period of time can be beneficial since you will be taxed at a lower rate (explained more below). If you’re in the 24% tax bracket and sell a short term investment, it could potentially propel you into the 32% tax bracket.
This is why financial & tax planning is so important!
Many people get themselves in tough situations by not knowing this information and then they’re stuck trying to figure out how to afford a hefty tax bill. Make sure that when you sell your investments that you’re also saving money to pay for the tax you’ll owe!
Long term capital gains come from investments that are held for longer than a year. They’re subject to a lower tax rate than short term capital gains. In 2022, the long-term capital gains tax rates are either 0%, 15%, or 20% (depending on your income).
The chart below shows what tax rate you correspond to based on income and how you choose to file your taxes.
To help explain this further, let’s look at another example.
Let’s say we have the same person as above who makes $100,000 and is a single filer. Let’s also say he bought an investment for $10,000, three years ago, and just sold it for $30,000 resulting in a gain of $20,000. To figure out what he owes in tax you first have to find his tax rate.
To reference the chart, since he makes $100,000 he has a capital gains tax rate of 15%. Then you multiply this number by the gain received from the sale ($20,000) resulting in $3,000 of tax. Once you know how it works, it’s fairly straightforward. But as you can see, holding this investment long term resulted in $1,800 less tax than the example above when the investment was held for less than a year and incurred short-term capital gains.
It’s important to note that you should never hold or sell based solely on taxes.
Cryptocurrencies are considered property for federal income tax purposes. This means crypto is considered a capital asset and you will pay the same tax when you ‘realize’ a gain or loss just like any other capital asset. Selling a capital asset means you will pay tax at your income rate when you sell within 12 months and will receive favorable long term capital gains rates when you hold longer than 1 year. No different than what we chatted about above.
One main difference is that wash sale rules do not apply to cryptocurrencies right now. This means you could sell your investment at a loss and then buy the same investment right back so you can have that loss to offset other gains. This is a powerful tool that can be used for tax-loss harvesting (offsetting gains with losses). With stocks, you would have to wait 30 days to buy the stock back after the sale due to the wash sale rule, but you don’t have to wait with crypto. This is a more complex strategy, so talk with your CPA or advisor on how to use it wisely.
Where people get confused with crypto is knowing what is considered taxable and what is not. So here’s a quick list of common transactions to help you get a better understanding:
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