Capital Gains Tax: Understanding Your Profits (and Taxes) from Stock Sales

Capital gains tax is a tax on the profit you make when you sell an asset like stocks, bonds, real estate, or even cryptocurrency. It’s the difference between what you paid for the asset (your cost basis) and what you sold it for (the sale price). Think of it as the government’s cut of your investment success.

Key takeaways:

• Capital gains are taxed only when you sell an asset, not while you hold it.
• The tax rate depends on how long you held the asset (short-term vs. long-term).
• Different rules and rates can apply to different asset types (e.g., qualified small business stock).

Short-term vs. Long-term Capital Gains:

The length of time you own an asset before selling determines whether your gains are taxed at short-term or long-term rates.

• Short-term: Assets held for one year or less. These gains are taxed at your ordinary income tax rate (the same rate you pay on your salary or wages).
• Long-term: Assets held for more than one year. These gains are generally taxed at lower rates than your ordinary income, offering a potential tax advantage.

Example:

Imagine you bought shares in a private company for $10 each and later sold them for $50 each. Your capital gain per share would be $40 ($50 - $10). If you held the shares for less than a year, this would be a short-term gain. If you held them for more than a year, it’s a long-term gain, potentially taxed at a lower rate.

Calculating Your Tax:

1. Determine your cost basis: This is typically what you originally paid for the asset, plus any fees or commissions. For stock options, this can be slightly different. See our wiki on Tax Basis Calculating Your Cost for more details.
2. Subtract your cost basis from the sale price: This gives you your capital gain (or loss, if you sell for less than you bought).
3. Apply the appropriate tax rate: This depends on whether your gain is short-term or long-term.

Special Considerations:

• Qualified Small Business Stock (QSBS): Investments in certain qualifying small businesses may offer significant tax advantages, potentially allowing you to exclude a portion (or even all) of your capital gains from taxation. Learn more on our Qualified Small Business Stock QSBS Potential Tax Savings page.
• Alternative Minimum Tax (AMT): While less common now, certain capital gains situations can still trigger the AMT, a separate tax calculation that may result in a higher tax bill. Our Alternative Minimum Tax AMT page explains this in detail.

Why this matters:

Understanding capital gains tax is crucial for making informed investment decisions. Knowing the potential tax implications can help you optimize your selling strategy and maximize your after-tax returns. Earlyasset’s Portfolio Tracker can help you track your private company valuations and potentially identify optimal liquidity windows, factoring in potential tax considerations.

So here’s what we covered:

• Definition of capital gains tax
• Difference between short-term and long-term gains
• How to calculate your capital gains tax
• Special considerations like QSBS and AMT
• The importance of understanding capital gains tax for investment decisions

Learn More: Consult with a qualified tax advisor for personalized guidance based on your specific situation.