Capital Gains Tax Rates 2020-2021 Guide

When your investment rises in value, there’s usually a tax implication.

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When you sell a valuable asset such as real estate or stock for more than you purchased it, you end up with a capital gain. As with other types of financial gains, the Internal Revenue Service (IRS) expects you to pay taxes on this profit. The capital gains tax rate you’ll pay depends on a couple of factors, including whether it’s a short-term or long-term financial gain and your taxable income. 

Key Takeaways

  • Capital gains occur when you hold an asset and sell it for a profit; short-term gains are held for less than a year, while long-term gains are held for more than a year.
  • The adjusted basis is how much an asset costs you, and is used to calculate taxes on capital gains.
  • Short-term capital gains are taxed as regular income.
  • Long-term capital gains are taxed at variable rates, with many opportunities to minimize tax liability through strategic investing.
  • The tax code is complex with regard to capital gains, and there are many exceptions and special circumstances to be aware of.

Short-Term vs. Long-Term Capital Gains

A capital gain is the profit you earn from selling an asset for more than you paid for it. These gains are subject to capital gains taxes. Capital gains are taxed depending on how long you held the asset before selling it.

A short-term capital gain occurs when you hold an asset for less than one year and then sell for a profit.

Suppose you buy stock in your favorite company. A few months later, the stock’s price goes up, and you decide to sell your shares to lock in your gains. Because you’ve held the stock for less than one year, the money you make is considered a short-term capital gain.

A long-term capital gain occurs in cases where you sell for a profit after holding an asset for more than one year. If you had purchased that same stock of your favorite company but held onto your shares for a few years rather than a few months, then selling for a profit would result in a long-term capital gain.

One common example of when you might pay long-term capital gains taxes (or not pay them, depending on your income) would be the case of buy-and-hold investing. People who use this strategy often put their money into investments such as index funds or exchange-traded funds (ETFs) and then hold them for long periods, often many years. When you ultimately sell your investments, any profits you’ve made could be subject to long-term capital gains.

How Capital Gains Are Calculated

Capital gains tax is paid on the difference between an asset’s adjusted basis and the amount you sell it for. In most cases, the adjusted basis simply refers to the amount an item costs you. For example, if you purchase a share of stock for $50, your basis is $50 plus any fees or commissions you paid.

Suppose you bought that $50 share of stock and paid $1.25 in fees. Your adjusted basis would be $51.25. Now suppose that one year later, you sold that same share of stock for $70. Your capital gain is the difference between $51.25 and $70, which is equal to $18.75. You’d paid taxes on the $18.75.

2020-2021 Capital Gains Tax Rates

Long-term capital gains taxes apply when you sell an asset at a profit after holding it for more than one year. The tax rate on these gains ranges from 0% to 20%, depending on your annual taxable income. 

As of the spring of 2021, the IRS still had not yet released an updated version of Publication 550, the information used for investment income and expenses, including capital gains and losses.

Single taxpayers and those married and filing separately won’t pay capital gains taxes if their income was $40,000 or less in 2020, and $40,400 in 2021, according to tax preparer eFile. The threshold is slightly higher for heads of household and twice as much for married couples filing jointly. For tax year 2020, only single people who made more than $441,450, and married couples who earned $496,601 or more will pay the highest capital gains tax rate.

Long-Term Capital Gains Tax Rates for Tax Year 2020

Capital Gains Tax Rate Taxable Income, Single Taxable Income, Married Filing Separately Taxable Income, Head of Household Taxable Income, Married Filing Jointly
0% Up to $40,000 Up to $40,000 Up to $53,600 Up to $80,000
15% $40,001 to $441,450 $40,001 to $248,300 $53,601 to $496,050 $80,001 to $496,600
20% $441,451 or more $248,301 or more $496,051 or more $496,601 or more

Long-Term Capital Gains Tax Rates for Tax Year 2021

Capital Gains Tax Rate Taxable Income, Single Taxable Income, Married Filing Separately Taxable Income, Head of Household Taxable Income, Married Filing Jointly
0% Up to $40,400 $40,400 Up to $54,100 Up to $80,800
15% $40,401 to $445,850 $40,401 to $250,800 $54,101 to $473,750 $80,801 to $501,600
20% $445,851 or more $250,801 or more $473,751 or more $501,601 or more

Short-Term Capital Gains Tax

A short-term capital gains tax applies when you sell an asset after holding it for less than one year. Unlike long-term capital gains, short-term capital gains are taxed as ordinary, or regular, income. As a result, you can expect to pay taxes on those gains at the same rate you’d pay in income taxes. Depending on how much you earn, you could pay anywhere from 10% to 37% on those gains.

Investors who may find themselves paying short-term capital gains taxes include day traders who buy and sell shares throughout the day in an effort to time the market. 

Suppose you decided to try your hand at day trading and make a profit of $1,000 throughout the year. When tax time rolls around, you’ll pay taxes on those gains at the same rate as your ordinary income. So, if you end the year with $60,000 in taxable income, including your day trading profits, then you can expect to pay as much as 22% in taxes on that portion of your income.

How to Minimize Capital Gains Taxes

Hold Your Investments Longer

The long-term capital gains tax rate is usually lower than the rate for short-term capital gains. Consider this: An individual making up to $39,000 in taxable income or a married couple making up to $79,000 will pay no taxes at all on a long-term capital gain. Yet, the same people would pay up to 12% for a short-term capital gain. And for especially high earners, the difference could be 20% for long-term capital gains versus 37% for short-term capital gains earned in tax year 2020.

One of the easiest ways to reduce your capital gains taxes is to hold your asset for at least one year.

Invest in Tax-Advantaged Retirement Accounts

Tax-advantaged retirement accounts such as 401(k)s and individual retirement accounts (IRAs) aren’t subject to the same capital gains taxes that other investments are. Investors can buy and sell assets within these accounts without worrying about paying capital gains taxes. These tax-advantaged rules also apply to 529 college savings plans.

Tax Advantage of Tax-Loss Harvesting

Tax-loss harvesting is a strategy that involves selling securities at a loss to offset the amount of the gain you made on other investments that you sold. This strategy helps reduce your overall tax liability because the loss can help cancel out the gain.

For example, suppose you invest $1,000 in Fund A and $1,000 in Fund B. One year later, you sell Fund A at $1,300 and Fund B at $500. You realized a gain of $300 with Fund A and a loss of $500 with Fund B. You wouldn’t owe any tax on the gain, because you lost more than you gained. That amount can also help you reduce your taxable income.

Claim Your Capital Losses

The IRS allows you to claim your capital losses up to a certain amount and use them to offset your capital gains. A capital loss occurs when you sell an asset for less than you paid for it. When you file your taxes, be sure to claim any losses to help reduce your capital gains tax burden.

Pay Attention to Your Income Before Selling for a Gain

When you sell an asset and experience a long-term capital gain, the rate at which it's taxed depends on your income for the year. If your income is right over the border of a capital gains tax bracket, consider holding the asset until a year when your income might be lower. 

Just a small change in your income can make a pretty significant difference. For example, someone making $39,000 in taxable income might not pay any long-term capital gains taxes at all, while someone with $41,000 in taxable income would pay 15% in long-term capital gains taxes.

It’s a small difference in income, but a big gap in the amount you’d pay in capital gains taxes.

If you don’t anticipate your income going down in the future, consider finding other ways to reduce your taxable income, such as looking for new deductions to qualify for. For example, slightly increasing your deductible contributions to a retirement account may reduce your taxable income enough to bring you down to a lower long-term capital gains tax rate.

Take Advantage of the Exclusion for Your Home

The IRS offers a capital gains exclusion to homeowners who are selling their primary residence. If you sell your home for more than you bought it, be sure to take advantage of the exclusion amount when filing your taxes (more on this below).

Unusual Capital Gains Situations

While the short-term and long-term capital gains rules apply to many investments, there are a handful of exceptions.

Capital Gains on Mutual Funds

Capital gains apply slightly differently to mutual funds. Unlike other types of assets, you might be subject to capital gains taxes for your mutual fund holdings even if you don’t sell your shares.

Throughout the year, mutual fund companies must pass earnings on to shareholders in the form of distributions. Even if you reinvest your distributions back into the fund, you’ll still have to report and pay capital gains taxes on them.

If you invest in a mutual fund and receive distributions subject to capital gains taxes, you’ll receive an IRS Form 1099-DIV.

Capital Gains on Your Primary Residence

When you sell your primary residence, you might be able to exclude some of the profits from capital gains tax. You may exclude the first $250,000 (or $500,000 for married couples) of your capital gain from taxes if:

  • You owned the home for at least two of the past five years
  • You owned the home and used it as your residence for at least two of the past five years
  • You didn’t sell another home during the two years before the date of sale or didn’t take an exclusion from the sale

Capital Gains on Collectibles

The tax rate on capital gains from the sale of collectibles, such as coins or art, is 28%.

Capital Gains on Depreciated Property

The IRS taxes unrecaptured Section 1250 gains at a rate of 25%. This section of the tax code applies to property you own that has depreciated in value over time, resulting in a tax break.

Capital Gains on Small Business Stock

If you sell qualified small business stock and receive a capital gain, you’ll be taxed at a rate of 28%.

Net Investment Income Tax

Depending on your annual income, you might also be subject to the net investment income tax (NIIT). This rule results in an additional 3.8% tax on certain investment income for single filers with a modified adjusted gross income (MAGI) of $200,000 or more, and married individuals filing jointly with a MAGI of $250,000 or more.