When you sell stock market investments, such as stocks, mutual funds and bonds, or property, for a profit, capital gains tax must be paid. The tax paid falls into one of two categories:
- Long-term capital gains tax; and
- Short-term capital gains tax
The amount of income you earn annually and the timeline you hold the asset affects the taxable amount payable to the IRS.
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Long-Term Capital Gains Tax
Long-term capital gains tax is charged on assets that are sold for a profit and have been held for at least 366 days, starting from the day the asset was acquired.
Assets held for a year and a day before being sold for a profit trigger a long-term capital gains tax liability. The long-term capital gains tax rate is usually lower than the standard income tax rate.
The timeline for holding an asset in order to benefit from the lower long-term capital gains tax rate relative to the higher short-term capital gains tax rate begins when the asset is purchased. For example, an investor purchasing an asset on January 1st of one year and selling it on January 1st of the next year will be subject to a short-term capital gains tax rate. To qualify for the lower long-term capital gains tax rate, the asset would need to be held one extra day, until January 2nd of the following year.
Short-Term Capital Gains Tax
Short-term capital gains are taxed at the same rate as ordinary income.
When an asset, such as a mutual fund, is held for a period of 365 days or less, and sold for a profit, a short-term capital gains tax rate is incurred. Short-term capital gains are taxed at the same rate as ordinary income, and so short-term capital gains tax liability tends to be sharply higher than long-term capital gains tax liability.
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How Funding a Robo-Advisory Account Affects Taxes
Many robo-advisors require accounts to be funded with cash because transfers in-kind of existing assets are restricted. Liquidating existing portfolio assets to fund a new robo-advisory account could have significant tax consequences.
Investors considering robo-advisors, such as Fidelity Go, Future Advisor, or Vanguard Personal Advisor Services among others, should be especially thoughtful before liquidating brokerage accounts to fund a new robo-advisory account. Many of these robo-advisory firms do not permit transfers in-kind, meaning you cannot simply transfer your holdings, you are required to liquidate them to cash first. Selling existing holdings may trigger capital gains taxes that could have a sizeable impact on your portfolio.
A good tax preparer can help guide you to ensure you are minimizing your tax liability. If you are unsure what the tax consequence of selling an asset for a profit is, ask your tax preparer before you make the sale; once the sale is made, it’s typically too late to subsequently undo the transaction to benefit from lower longer-term capital gains tax rates.
How Income Impacts Capital Gains Taxes
High income earners who fall into the highest Federal income tax bracket pay higher long-term capitals gains tax rates than earners in lower tax brackets.
The IRS applies a sliding scale to income tax rates and capital gains tax rates. Earners falling into the lowest income tax brackets (taxed at rates of 10% and 15%) may qualify to pay no capital gains tax whatsoever. Higher income earners will typically pay higher capital gains tax rates.
Earners who pay income tax rates at the levels of 25%, 28%, 33% or 35% will qualify for a 15% long-term capital gains rate while earners who fall into the highest federal income tax bracket, 39.6%, are subjected to a capital gains tax rate of 20%.
What Is Net Investment Income Tax?
Net Investment Income Tax (NIIT) is an additional tax that applies to high earners above certain threshold levels.
The Net Investment Income Tax is charged to trusts, estates and individuals with net investment income above certain key levels. For the most part, Net Investment Income Tax applies when the following adjusted gross income threshold levels are exceeded:
- $125,000 for spouses filing separately
- $250,000 for spouses filing jointly
- $200,000 for all other filings
Net Investment Income Tax can be a little tricky but can be easily calculated by a good tax software program.
How Real Estate Sales Affects Capital Gains Tax
Higher capital gains tax rates are incurred when profitable real estate sales are made in which a depreciation allowance has previously been claimed.
Although the long-term capital gains tax rate is capped at 20% for the most part, profitable real estate sales incur a capital gains tax rate of 25%. This is true when a depreciation allowance has been claimed. If you’re not sure whether that is the case, consult with your tax preparer.
How Selling Art And Collectibles Affects Capital Gains Tax
Collectors of art, coins and collectibles are taxed at higher rates than long-term capital gains tax.
Profitable sales of art, coins and collectibles are taxed at 28%, higher than long-term capital gains tax.