How much is capital gains tax, and how does it work?

Most of the taxes we pay are income taxes. We earn income from our jobs, businesses, or side hustles, and the government takes a percentage. A chunk of the money you see taken out of your paycheck each month is probably taxes. Taxes are inevitable, but making sure we report them accurately is one important step in managing our personal finances.

Capital gains tax is another common tax that affects investors. It’s essentially a tax on the profits you make from investments. But how much is capital gains tax, and how does it all work?

This detailed guide will go over how capital gains taxes work, the current capital gains tax rates for 2023, and how to minimize the effects of these taxes on your investment strategy.

What is capital gains tax?

Capital gains tax is a tax paid by investors after they sell investments at a profit. The tax is assessed on the profits of the sale.

For example, say that two years ago, you bought Apple stock for $1,000. And now, after the stock has grown in value, you sell it for $1,600. Your profit is $600 ($1,600-$1,000).

In this scenario, capital gains tax would be assessed on that $600 profit.

The amount of the capital gain is calculated by taking the sale price, minus the purchase price, minus any qualifying expenses, if relevant.

Keep in mind that capital gains tax only kicks in when you sell an investment. You won’t owe capital gains until you sell, even if the price of the stock goes up. (Although, you might owe income tax on any dividends you earn, which are considered taxable income.)

State taxes may also apply in some cases. Each state has its own rules for capital gains and tax liability. This blog will focus on federal tax filing requirements for capital gains. A must-read for all kinds of investors — especially those who are just getting started.

How much is capital gains tax in 2023?

Capital gains tax ranges from 0% to 20%, depending on your income tax bracket. Tax brackets are based on how much money you earn; in general, the higher your income, the higher percentage you pay in taxes. 

There are a few things to understand before we get into the details:

• Capital gain: When an asset is sold at a profit

• Capital loss: When an asset is sold at a loss

• Short-term capital gains: When an asset is sold at a profit less than one year after purchasing it

• Long-term capital gains: When an asset is sold at a profit one year or more after purchasing it

If you buy a stock today for $500 and sell it six months later for $700, you’d have a short-term capital gain of $200. If you held onto it for 14 months and then sold it for $800, you’d have a long-term capital gain of $300.

This distinction is important to understand because short-term capital gains are taxed as ordinary income, while long-term gains are subject to a different tax rate.

Short-term capital gains tax rates 

Short-term capital gains occur when an asset is sold at a profit less than 12 months after its original purchase date.

Short-term gains are taxed at ordinary income tax rates, which means whatever your standard income tax rate is, it will also apply to your short-term gains. For the 2022 tax year, your short-term capital gains tax rate could be between 10% and 37%, depending on your income level. 

Your tax rate is based on which tax bracket you belong to. The Internal Revenue Service (IRS) sets the tax brackets — based on income level and filing status — for each tax year.

Long-term capital gains tax rates 

Long-term capital gains occur when an asset is sold at a profit more than 12 months after its original purchase date.

Long-term gains are taxed at a completely different rate from normal income. However, the rate still varies depending on your tax bracket. In general, long-term gains are taxed at lower rates than short-term gains.

As of 2023, your long-term capital gains tax rate will be 0%, 15%, or 20% depending on your income level and filing status.

Exceptions and special circumstances

Most assets and situations fall under the standard capital gains tax rates discussed above. But there are a few exceptions. For instance, real estate is sometimes treated differently — and it depends if the owner lives in the home or not. 

Be sure to check with your tax advisor if you have any questions related to capital gains taxes and how they apply to your situation.

What does “net capital gains” mean?

Another important thing to understand is that the IRS looks at your total profits and losses from investments when they calculate capital gains tax.

Any qualifying losses will offset qualifying gains.

For instance, say you invest in two stocks: Company A for $1,000, and Company B for $1,000. Your total investment is $2,000.

A year later, you sell both stocks. Company A has performed well and is now worth $1,400. Company B has declined to a value of $800. Your total net sale is $2,200.

In this scenario, your net capital gain is $200. You invested $2,000 and ended up with $2,200.

The IRS will still want to know about the details of each stock sale. But in the end, the amount you’ll actually be taxed on is your net gain.

What happens if you lose money on investments?

If you end a tax year with a net loss on the investments you’ve sold, you won’t owe any capital gains tax.

In fact, you may even be able to deduct those losses from your regular income, which could lower your tax bill.

For instance, say you earn $45,000 at your job. You sold some investments at a loss, with a net capital loss of $1,000. This would lower your taxable income to $44,000, which would in turn lower the amount of federal taxes you would have to pay.

However, this deduction is capped at $3,000 per year (for single filers). If you have more than $3,000 in net capital losses in a year, you can carry the excess loss over to future years.

For example, say you sold assets in 2022 for a net loss of $12,000. You could then claim a $3,000 deduction on your 2022 tax return and then an additional $3,000 on your 2023, 2024, and 2025 taxes.

If you have concerns over how to handle your capital gains or capital losses come tax-time, you can work with a CPA or tax advisor.

When are capital gains taxes applicable?

Capital gains tax applies whenever an asset is sold at a profit, unless the asset is held in a tax-advantaged retirement account. If you have investments in a 401(k), Roth IRA, 529 plan, or other tax-advantaged account, you won’t owe capital gains tax — but you may still owe income taxes when you take distributions eventually.

If you buy stocks, mutual funds, bonds, or other assets in a standard brokerage account, and later sell them at a profit, you will owe capital gains tax. Your broker will prepare a tax statement (1099-B) that makes it easier to file your taxes.

But not all sales of investments will result in a helpful tax form. Home sales are one example. Real estate is subject to capital gains taxes, although there are some generous exemptions in place for many tax filers.

Likewise, investments in alternative assets like cryptocurrency won’t result in any tax form.

The bottom line is this: Whenever you sell an asset for a profit, you will owe capital gains tax. The only exception is if the asset is held in a tax-advantaged account, like an IRA.

What about the net investment income tax (NIIT)?

High-income households may be subject to the net investment income tax (NIIT) in addition to standard capital gains taxes. The NIIT is 3.8%.

If either your net investment income or your modified adjusted gross income (MAGI) exceeds certain thresholds, the NIIT may apply.

If you’re in a high-income household, it’s wise to work with a tax advisor or tax preparer who can help you navigate all the rules and find more tax deductions or credits for your given situation.

It’s never too early to start investing.

Whether you invest in the stock market or sell a personal asset like a home, you’ll likely owe taxes on the profit. The tax rate will depend on whether it was a short-term or long-term capital gain. You can figure out how much you owe with tax software or the help of a CPA.

Investing = a wealth building tool for a brighter financial future. Did you know? Every $1 invested today could turn into $7.61 in 30 years (assuming 7%* returns). The best part: It’s never too late or too early to start. 

Greenlight tip: For investment or tax information specific to your situation, consult a tax professional or financial advisor.

Greenlight is a banking**, investing, saving, and financial literacy app designed for kids and teens. Parents and kids can work together and learn to invest with as little as $1. Get started with Greenlight today!

*Using Shiller’s data, since 1971 the S&P 500 has delivered an annualized return of 7.58%.

**Greenlight is a financial technology company, not a bank. Banking services provided by Community Federal Savings Bank, Member FDIC.