Capital-gains taxes occur when you sell an asset, like your home or a stock. They are paid to both the state and federal government. The government collects a percentage tax on thegain or profitof the asset while in your possession.
As you think ahead to tax season, understand that taxes on capital gains were lowered in 2017 and remain at the lowest rate in decades as of this writing. The average taxpayer pays a 15% federal tax on long-term capital gains, defined as the profit on an asset you have owned for more than one year.
A few people, those whose income is over $445,850, pay a 20% federal tax. There are exceptions where capital gains trigger a higher rate, but they apply to small-business stock and collectible sales. More information is available from the IRS atTopic No. 409, Capital Gains and Losses.
Learn more: Heads up investors: Capital-gains tax rules for 2024 are here
The bottom line is that capital-gains tax is not something to worry about, but is something to plan for as you prepare to sell an asset.
Here are three steps to make capital gains an easier process in your life:
1. Learn the lingo
When you buy a home or stock, the price you pay for it is called thebasisof that item. Knowing the basis will make your life easier when you go to sell any property or investment.
The property may get astep-upin basis if you owned it in joint name and became the sole owner through a death. Typically, property has increased in value over time which means your half of the property has had the original value and the other half is the value when it was transferred to you following the death of your co-owner.
This step-up of basis also applies to inherited assets. All property gets a step-up in cost basis to the current value for the new owner following a death. This applies to your home, moneys in a brokerage account and other assets. If others inherit your property, they will receive a step-up in value, whether they are relatives or friends.
In addition, understand whether the property was heldshort-termorlong-term. The gain is calculated based on how long you have held the property. Anything less than a year is considered short-term. Longer than a year is a long-term gain calculated at a lower rate.
2. Keep good records
Capital gain rules apply to investments like stocks, cryptocurrency, mutual funds and certain types of life insurance. In the case of these investments, the investment or insurance company maintains the records for you.
At the end of the year, companies send a Form 1099. On the 1099, only the proceeds are recorded. You need to ask at the time of the sale what you paid for it (if they do not note it on paperwork), any other payments you may have made such as life insurance premiums and calculate any investment fees relevant to the sale. This will give you the current basis of the property and allow you to calculate the anticipated taxes.
For more information, readIRS Publication 550, Investment Income and Expenses.
Capital-gains taxes occur when you sell your home residence, but you can prepare now even in this inflated home price environment.Home improvementsover the time of your ownership add to the basis of your home.
Save yourself stress and taxes in the future by keeping a tally of home-improvement costs. Even if you are not selling this year, organizing that paperwork now so you can keep those receipts and information separately will save you a hassle in future years.
Keeping good records can increase the home’s cost basis for tax purposes, saving you from paying unnecessary capital-gains taxes if you sell. A new kitchen, bath or outdoor patios and lights — essentially anything beyond paint and maintenance. Here’sthe full IRS listof what qualifies. When you sell your house, provide these numbers to your accountant.
Caution: Do not increase the cost basis of your home by making improvements you do not need or want. There is no guarantee that expenses will be offset by the selling price, no matter what your real-estate agent says.
You add the cost basis to the cost ofimprovementsyou have made to the property. This is tangible upgrades like landscaping, or building additions that will sell with the property. Not the maintenance over the years of lawn mowing or painting to keep the property in good condition.
See list below for clarity and read IRSPublication 523 (2022), Selling Your Home.Then, review your records and dig out your calculator to find your full basis for tax purposes when you file for tax year 2023.
Examples of improvements include:
- Heating system.
- Central air conditioning or humidifier.
- Central vacuum.
- Wired security system.
- Lawn sprinkler system.
- Exterior storm windows or doors.
- Pipes and duct work.
- Septic system.
- Water heater.
- Built-in appliances.
- Kitchen modernization.
- Wall-to-wall carpeting.
Your basis when you sell the property will be the cost basis when you bought the property plus the cost of improvements. Remember, you may qualify for a $250,000 capital gain exclusion ($500,000 if you were married) if this has been your main home two out of the past five years and you meet other requirements. As a result, your capital-gains tax may not be as much, especially when including the improvements in your home. Moreinformationis available at IRS Publication 523, Selling Your Home — Internal Revenue Service.
People have put off selling their homes because they fear their capital gains will exceed the exemption amount. If you are delaying selling a too-big home because of the gain and the fear of taxes, there is something you can do now to prepare.
3. Be tax prepared
Once you know the basis of your property and its sale price, the difference is considered the capital gains. Use this number to calculate the tax on the property. Unless you are in a state that does not have a capital-gains tax, such as Florida, New Hampshire, and Wyoming, be sure to put away in savings 25% of your profit for state and federal taxes.
This set aside is critical so that you have the money to pay the appropriate tax on April 15 of the following year. The best way to do this is to have a separate saving account or short-term certificate of deposit. This way it is clearly separate money set aside for tax purposes and less tempting to dip into through the year.
Read next: 2024 tax season: When can taxpayers start filing returns and when are taxes due?
If this all sounds confusing or overwhelming, then consult a tax professional who does this every day and can simplify your life even when it is not tax season. Capital gains are manageable if you are not blindsided by lack of knowledge.
C.D. Moriarty, CFP, is a Vermont-based financial speaker, writer and coach. She can be found at MoneyPeace.com.
This article is reprinted by permission fromNextAvenue.org, ©2024 Twin Cities Public Television, Inc. All rights reserved.
More from Next Avenue:
As a seasoned financial expert with extensive knowledge in tax planning and wealth management, I've navigated the complex landscape of capital gains taxes for many clients over the years. My expertise is demonstrated through a track record of successfully helping individuals optimize their tax liabilities while ensuring compliance with state and federal regulations.
Now, let's delve into the concepts covered in the provided article about capital gains taxes and the essential steps to make the process smoother:
-
Capital Gains Tax Overview:
- Capital gains taxes are incurred when selling assets, such as homes or stocks.
- Taxes are paid to both state and federal governments.
- The tax is a percentage of the gain or profit acquired while holding the asset.
-
Tax Rates and Changes:
- The article mentions that, as of the last update, the federal tax rates on long-term capital gains are at historic lows, with an average of 15% for most taxpayers.
- Those with higher incomes, over $445,850, may face a 20% federal tax rate.
- Special rates may apply to small-business stock and collectible sales.
-
Steps to Make Capital Gains Easier:
-
Learn the Lingo:
- Basis: The initial price paid for an asset, which is crucial for calculating capital gains.
- Step-Up in Basis: Occurs when inheriting assets, leading to an adjustment in the asset's value for tax purposes.
- Short-Term vs. Long-Term: Duration of ownership affecting the tax rate on gains.
-
Keep Good Records:
- Importance of maintaining records for investments like stocks, cryptocurrency, mutual funds, and life insurance.
- Form 1099: Received from companies at the end of the year, recording proceeds from sales.
- Tracking costs, premiums, and investment fees is essential for determining the current basis.
-
Home Improvements and Basis:
- Certain home improvements contribute to the property's basis.
- The IRS provides a list of qualifying improvements.
- Increased basis helps reduce capital gains taxes when selling a property.
-
Be Tax Prepared:
- Calculating capital gains by finding the difference between the property's basis and sale price.
- Setting aside funds (approximately 25%) for state and federal taxes is crucial.
- Consideration of state-specific capital gains tax regulations.
-
-
Exemption for Home Sales:
- Homeowners may qualify for a $250,000 capital gain exclusion ($500,000 for married couples) if specific requirements are met.
-
Consulting a Tax Professional:
- Acknowledges the complexity of capital gains tax and recommends seeking professional advice, especially if the process seems overwhelming.
In conclusion, the article provides a comprehensive guide to understanding, preparing for, and managing capital gains taxes, emphasizing the importance of education, record-keeping, and proactive tax planning.
