Part of being financially smart is knowing exactly what kind of tax bill may face for different levels of income or investments. While some parts of the US tax code can be fairly straightforward, there are a few exceptions you should be aware of in case this applies to you.
How capital gains taxes work
To begin with, many investments follow the traditional Capital Gains Tax Rates. Short-term capital gains, those held for less than a year, are taxed at regular income tax rates. Investments held for more than a year receive favorable tax treatment and are much simpler. There are three main capital gains tax brackets:
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|Capital gains rate||Income range (individual)||Income Range (Married Filing Jointly)|
|0%||$0 to $40,400||$0 to $80,800|
|fifteen%||$40,401 to $445,850||$80,801 to $501,600|
|twenty%||$445,851 or more||$501,601 or more|
For example, if you bought shares of stock in a company for $1,000, held them for nine months, and then sold them for $1,500, you owe your tax percentage on the $500 gain. If you bought those same shares and held them for two years before if you sell them, you would have to pay your capital gains rate. While the vast majority of investments fall under these simple capital gains brackets, there are three exceptions you should be aware of in case this applies to you.
1. How collectibles are taxed
Collectibles such as rare items, works of art, gold and silver coins, stamps, and antiques are considered alternative assets by the IRS. Let’s say you bought a piece of art for $10,000 and then sold it for $50,000. Assume you are in the highest ordinary income tax bracket. Under normal circumstances, you would pay 20% of the $40,000 ($8,000) profit. However, since the art is considered a collectible, you would pay a higher rate of 28%, which would make your tax bill $11,200.
While regular exchange-traded funds (ETFs) are taxed at regular capital gains rates, ETFs that are backed by gold or silver fall into the collectible category and also face the 28% rate. %, so make sure you don’t underestimate your potential tax bill by using your typical capital gains rate to calculate what you owe.
2. How Qualified Small Business Stocks Are Taxed
If you sell Qualified Small Business (QSBS) stock, the greater of $10 million or 10 times your adjusted basis, the cost you paid for it, you’re free from capital gains tax if you’ve held it for at least five years (unless the business operates in financial services, agriculture, restaurants, or hotels).
For example, if you bought 100,000 shares of a company at initial issue for $15 each ($1.5 million total) and more than five years later sold all of the shares, up to $15 million would be exempt. If you had bought those same 100,000 shares for $5 ($500,000) and then sold them, $10 million would be exempt. Unfortunately, any excess income above the exemption will face a 28% capital gains tax.
3. How property is taxed under Section 1250
Section 1250 of the Internal Revenue Code (IRC) focuses on taxing gains made from the sale of depreciated real property, which could be commercial buildings, rental properties, or warehouses. Suppose you bought a warehouse for $250,000 and a few years later it has depreciated by $50,000, so your tax base is $200,000. If you were to sell the property for $225,000, your taxable gain would be $25,000.
Under normal circumstances, that $25,000 in earnings would be subject to your typical capital gains rate, but since it falls under IRC Section 1250, it will be taxed at the 25% rate.
Knowing can help your financial planning
One of the keys to successful financial planning is knowing your expenses, and for people selling assets of any kind, part of those expenses will likely include capital gains taxes. Using the wrong capital gains rate and miscalculating what you may owe can result in a bill that’s thousands more than you anticipated and mess up your planning. To prevent this from happening, one of the best things you can do is to know what category your assets fall into and whether they are an exception to typical rates.
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