The federal government considers anything you own or use as a capital asset, including your financial investments. In other words, it has a monetary value. If you sell these assets, the difference between the price you paid for it — adjusted to reflect valuation changes since purchase — and the sale price is a capital gain or loss.
Though the money isn’t earned income, any gains are subject to taxes (capital gains tax), but the rate depends on how long you owned the asset before selling it. However, you do have options for deferral. Deferral is often beneficial for real estate sales, sale of a business or sale of a highly appreciated collectable.
What Is the Difference Between Short-Term and Long-Term Capital Gains?
The difference between a short- and long-term capital gain is the time you own the asset before selling it. If you sell it within a year of your purchase and profit from it, it is a short-term capital gain. Long-term capital gains are profits on assets held for longer than a year before selling.
Are Tax Rates the Same for Short- and Long-Term Capital Gains?
The federal government establishes different tax rates for short-term vs. long-term capital gains. Profits from assets held less than a year have a higher tax rate than those held longer. The Internal Revenue Service’s short-term tax rate equals the rate it charges for your income taxes. Your tax bracket determines the percentage you pay in taxes on your capital gains.
Long-term capital gains are taxed at a lower rate. Generally, the IRS tax rates are as follows:
- 0% for those with incomes of $41,675 or lower for singles, $83,350 for joint filers and $55,800 for head of household filers
- 15% for those with incomes between $41,676 and $459,750 for single filers, $83,351 and $517,200 for married couples, and $55,801 and $488,500 for head of household filers
- 20% for any filers whose income exceeds the maximum level for the 15% rate
The IRS identifies exceptions that can lead to higher tax rates on long-term capital gains. Additionally, most states also levy taxes on capital gains. The only states that don’t are the nine that also do not have an income tax.
Can You Defer Your Capital Gains Taxes?
You can defer your capital gains taxes using specific legal strategies. However, if you have long-term capital gains, you may want to calculate how much you would owe in taxes before deciding whether to opt for a deferral strategy. The benefits may not outweigh the loss of income, especially if you live in one of the nine states that don’t have a capital gains tax.
However, the higher tax rates you incur with short-term capital gains often make tax deferral an attractive option, particularly with higher profits. A 1031 Exchange is a common sales strategy for deferring capital gains taxes on investment property, but you may encounter challenges finding an appropriate property.
A second option is Reef Point’s Deferred Sales Trust. A DST gives you options for when and how you receive payments on the sale of a property. It may reduce your overall taxes on the property and provide a retirement income. It also protects your assets from probate, doesn’t compete with a charitable remainder trust and can rescue you from a 1031 Exchange failure.
If you are interested in deferring capital gains taxes, Reef Point can help. Contact us to learn more about DST.
Sources:
https://www.irs.gov/taxtopics/tc409
https://worldpopulationreview.com/state-rankings/capital-gains-tax-by-state
https://www.realized1031.com/blog/what-does-tax-deferred-mean