What are Capital Gains Taxes?

A frequent tax question that arises concerns the capital gains tax. The capital gains tax is an income tax that can be levied when you realize a gain. A gain is realized when the assets that have appreciated in value are sold and you take possession of the liquidity.  Accordingly, capital gains taxes are not payable on assets that are received by an inheritance as that transfer is not a sale.  However, as discussed below, there are capital gains tax considerations when assets that are inherited are subject to capital gains tax treatment when they are sold by the recipient. Capital gains are divided into two distinct categories for income tax purposes. There are short-term capital gains, and long-term capital gains. A gain is a short-term capital gain when the asset in question is sold within one year of the original acquisition. Short-term capital gains are taxed at your regular income tax rate. With long-term capital gains, which are gains that are realized more than a year after the original purchase, the scenario is quite a bit different. The powers that be want to encourage long-term investing, so the rate on long-term capital gains is not equal to your regular income tax rate. The exact long-term capital gains rate that applies to you would be based on your income. For most people, the long-term capital gains rate is 15 percent at the present time. People in the very lowest income tax brackets pay no long-term capital gains taxes at all. At the present time, the maximum long-term capital gains rate is 20 percent. To find yourself in this bracket, you have to claim at least $418,400 as a single tax filer. If you are married and you are filing jointly, this figure rises to $470,000.  These figures may change if and when President Trump’s tax plan is enacted. High income earners may also be forced to pay a Medicare surtax on investment income. The rate of this tax is 3.8 percent, and it would be applicable if you are a single filer with an adjusted gross income over $200,000. This too may change if and when the health care law currently being debated in Congress to replace Obamacare is enacted. Estate Planning Implications When you hear about the existence of the capital gains tax, you may wonder about the estate planning implications. If you leave appreciated assets to your heirs, will they be forced to pay capital gains taxes if they sell the assets? The answer to this question is no. Inherited appreciated assets get a step-up in basis. The inheritors would not be responsible for the gains that took place during your life. For capital gains purposes, the value of the inherited assets would be equal to their value at the time of acquisition. However, if the assets continue to increase in value, the capital gains tax would be applicable if and when the gains are realized. Please note, this step up in basis does not apply to assets held in tax-deferred accounts, such as IRAs. You should have a basic understanding of how taxes can impact the estate that you will be passing along to your loved ones. If you have questions about taxation or any other estate planning matter, we would be glad to assist.