Money gurus are always preaching long-term investing. Not only will that give you a better shot at earning more, it'll also get you a lower tax rate when you sell.
But exactly what capital gains tax rate you pay depends on several things, including when you bought the asset, when you sold it, your overall income level, and sometimes, what tax-code changes were made in the meantime.
Currently, capital gains are at historic lows. Some taxpayers in the two lowest tax brackets could end up without any capital gains tax bill. That's right, zero capital gains for some filers.
Others will face tax rates of just 5%. Most investors will see their gains taxed at 15%. And 25% and 28% rates apply in special circumstances.
One thing all these tax levels do have in common is that they are known as long-term capital gains. This means they apply to assets that you hold for at least 366 days -- more than one year.
The tax appeal of the long-term capital gains tax rate is that it is generally much lower than what you pay on your regular income. In fact, it is a taxpayer's income level that generally determines which capital gains rate applies. And if your profit pushes you into a higher bracket, you could possibly be taxed at a combination of rates. And you could face yet another rate depending on the type of property you sell.
Zero Capital Gains Taxes for Some
On Jan. 1, 2008, the best of all possible tax rates -- zero percent -- took effect for investors in the 10% and 15% income tax brackets.
Previously these taxpayers had to pay Uncle Sam 5% of their long-term capital gains. Now any long-term assets they sell will be exempt from capital gains taxes.
|Filing status||Maximum taxable income|
|Single or Married filing separately||$34,000|
|Married filing jointly||$68,000|
|Head of household||$45,500|
To qualify for the zero rate, you must own the asset for more than one year before you sell it.
While lower-income individuals aren't typical investors, this tax benefit could help out folks such as retirees who have little or no taxable income. And the children of older individuals could combine the annual gift exclusion ($13,000 in 2010 and 2011) with this capital gains break and give appreciated long-term assets to their older parents.
15 Percent Tax Rate for Most
The zero percent rate is just the latest in a series of investor-friendly tax changes enacted during the George W. Bush administration. Prior to his taking office, investors whose overall income put them in the top four income tax brackets faced a long-term capital gains rate of 20%, while lower-income investors paid capital gains taxes of 10%.
Tax-law changes in May 2003, however, lowered the rates by 5% each, with the lower rate, as noted earlier, eventually being zeroed out in 2008. The lower rates were extended by the December 2010 tax bill through the 2012 tax year.
The changes have had the most effect on investors in the higher income ranges -- 25% to 35% tax brackets. These individuals now find their capital gains taxed at 15%. This lower rate also applies to some dividends that stocks and mutual funds pay account holders. When you hear "lower capital gains rate," it generally means this 15% level, because there are few investors with incomes low enough to qualify solely for the 5%, now zero percent, rate.
Remember, these rates are for long-term capital gains. In most cases, that means you have to hold an asset for more than a year before you sell it. If you cash it in sooner, you'll be taxed at the short-term rate, which is the same as your ordinary income tax level and could be as high as 35% on 2010 returns.
25 Percent Capital Gains Rate
While the 5% (now zero percent) and 15% rates have received the most attention, at least on Capitol Hill, for the last few years there have been several other categories of capital gains taxes.
A rate of 25% applies to part of the gain from selling real estate you depreciated. Basically this keeps you from getting a double tax break. The Internal Revenue Service first wants to recapture some of the tax breaks you've been getting via depreciation throughout the years. You'll have to complete the work sheet in the instructions for Schedule D to figure your gain (and tax rate) for this asset, known as Section 1250 property. More details on this type of holding and its taxation are available in IRS Publication 544, Sales and Other Dispositions of Assets.
28 Percent Capital Gains Rate
Two categories of capital gains are subject to this rate: small business stock and collectibles.
If you realized a gain from qualified small-business stock that you held more than five years, you generally can exclude one-half of your gain from income. The remainder is taxed at a 28% rate. If you've already hired a tax professional to help you sort out the 25% rate on depreciable property, she can help you figure this tax, too. Or you can get the specifics on gains on qualified small business stock in IRS Publication 550, Investment Income and Expenses.
If your gains came from collectibles rather than a business sale, you'll still pay the 28% rate. This includes proceeds from the sale of a work of art, antiques, gems, stamps, coins, precious metals and even pricey wine or brandy collections.
More Rate Changes to Come?
The capital gains tax rates are set through Dec. 31, 2012, but there continues to be a push by some in Washington, D.C., to return at least the top capital gains tax rate to the prior 20% level.
That decision will hinge in large part on the economy and future congressional and presidential elections.
With Congress continually tweaking investment tax laws, what's an investor to do? Most financial experts say to take advantage of today's lower rates while they are around and when they fit into your portfolio plans.
But don't forget about the Dec. 31, 2012 deadline. And definitely keep an eye on federal tax-law writers in the interim.