Long Term Capital Gains Tax Explained For Beginners

 

A Comprehensive Guide to Understanding Long-Term Capital Gains Tax

Long-term capital gains are an essential concept for anyone involved in the stock or cryptocurrency markets. Knowing how they work and their tax implications can save you a substantial amount of money. In this article, we'll break down what long-term capital gains are, how they're taxed, and how you can benefit from them.

What is a Capital Gain?

A capital gain is the profit you earn from selling an investment. It’s important to distinguish this from regular income, which you earn from your job. For example, if you sell your house or stocks at a profit, that gain is considered a capital gain. If you incur a loss from selling stocks, it’s termed a capital loss.

Types of Capital Gains

There are two types of capital gains: short-term and long-term. The distinction between them is based on how long you hold the investment before selling it:

• Short-term capital gains: These occur when you sell an investment you've held for one year or less. They are taxed at your regular income tax rates.
• Long-term capital gains: These occur when you sell an investment you've held for more than one year. These gains are taxed at lower, more favorable rates.

Tax Rates on Long-Term Capital Gains

Long-term capital gains are subject to three different tax rates: 0%, 15%, and 20%. The rate you pay depends on your total income. Here's how it breaks down:

• 0% Tax Rate: If you are single and your total yearly income is less than approximately $52,500, you will not pay any taxes on your long-term capital gains. This threshold is adjusted annually for inflation.
• 15% Tax Rate: If your total income falls between $52,500 and $454,000, your long-term capital gains will be taxed at 15%.
• 20% Tax Rate: If your total income exceeds $454,000, your long-term capital gains will be taxed at 20%.

Examples to Illustrate

Simple Example

Imagine you bought Tesla stock years ago, held onto it for more than a year, and then sold it for a $35,000 profit. If this is your only income, it's below the $52,500 threshold. Therefore, you'll pay 0% in taxes on this gain.

Complex Example

Suppose you have a job earning $50,000 annually, and you also sell Tesla stock after holding it for more than a year, earning a $20,000 profit. Your total income is now $70,000. Here’s how your taxes break down:

• Your employment income of $50,000 is taxed at regular rates.
• The next $2,500 of your stock gain is also taxed at 0%, since it stays within the $52,500 limit.
• The remaining $17,500 gain is taxed at the 15% long-term capital gains rate.

Additional Considerations

Net Investment Income Tax

In addition to the long-term capital gains tax, there's also the Net Investment Income Tax (NIIT) of 3.8%. This applies if you're single with a total income of $200,000 or more, or married filing jointly with an income of $250,000 or more. This tax is added on top of your capital gains taxes.

When Are You Taxed?

You only pay capital gains tax when you sell the investment. If you buy Bitcoin and its value increases but you don't sell it, you don't owe any taxes on the unrealized gains. The taxable event is the sale.

Conclusion

Understanding long-term capital gains and their tax implications can significantly impact your investment strategy and overall financial planning. By holding investments for more than a year, you can take advantage of lower tax rates and potentially save a considerable amount of money.