An Overview of Existing Capital Gains Tax Laws

Capital gains tax is a tax on the profits earned from stocks, bonds, precious metals, property and other forms of investment. There are a number of laws that regulate how different types of investments. Taxpayers should make sure they understand all those laws before filing their tax returns; otherwise they may not properly pay their taxes.

Short-Term vs. Long-Term Capital Gains Tax

Capital gains taxes can be divided into two groups - short-term capital gains taxes and long-term capital gains taxes. The difference between the two lies in the length of the holding period of the investment. The Holding period is the difference between the time the taxpayer made an investment and the time they sold the investment. Investments that are held for less than a year are known as short-term investments, long-term investments are investments that are held for more than a year.

The United States tax laws encourage long-term investments by taxing them at lower rates then short-term investments. Furthermore, taxpayers are only taxed when a profit is made. In other words, if a taxpayer sells his or her assets three years after purchasing, he or she will only have to pay taxes on the resulting gains during the third year.

Capital Gains Taxes and Income Brackets

The rate at which taxpayers are taxed depends on their tax bracket. Generally speaking, the lower the income brackets, the less the taxpayers have to pay. Taxpayers in 5 and 10 percent income brackets don't pay long-term capital gains taxes at all. Everybody else has to pay 15% of the value of the gain. When it comes to short term capital gain taxes, taxpayers have to pay between 10-46%, however the exact number depends on income brackets.

There are separate tax laws for long-term gains from the following types of investments:

  • Collectibles - taxpayers have to pay between 10 - 28%.
  • Small Business Stocks - taxpayers have to pay between 10 - 28%, if the holding period is longer than five years. Otherwise, standard rates apply.
  • Real Estate Main Home - this includes the taxpayer's place of residence. Taxpayers in 10% income bracket are charged 10%, tax payers in 15% income brackets are charged 15% and everybody else is charged 25% or more, depending on their tax bracket.

Lawful Ways to Avoid Capital Gains Taxes

Tax laws allow taxpayers to avoid paying taxes on their long-term capital gains. They include:

  • Putting their assets towards retirement - taxpayers can place their investments in retirement savings accounts such as the 401k or IRA accounts. The tax payer will not be able to use the money until they retire without additional fee assessments, including taxes.
  • Giving their assets to charity - if taxpayers donate their long term capital assets to charity, all parties are tax exempt. Taxpayers should remember that not all charities accept assets as donations. 

Contrary to popular assumption, US citizens are required to pay capital gains taxes even if they currently live outside the United States.

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