The only thing worse than taxes might be unexpected taxes. Nobody likes a surprise tax bill, especially one they can’t afford to pay. This is occasionally the case when a life event or investment decision results in the unplanned sale of stocks, real estate, or other property.
Problems may arise when taxpayers complete these transactions without accounting for their capital gains tax consequences. If this has happened to you, continue reading to learn more about how capital gains taxes work, why you might be facing this tax issue, and your options for overcoming this problem. To get help now, contact us at the W Tax Group.
Key Takeaways
- Capital gains taxes – taxes you pay on the profit received when selling a capital asset.
- Capital asset – almost any type of property, whether personal or business-related.
- Long-term gains – the property sold was owned for more than a year/
- Short-term gains – the property sold was owned for one year or less.
- Tax rate – short-term capital gains are generally taxed at the same rate as your ordinary income. Long-term capital gains are usually taxed at either 0%, 15%, or 20%, depending on your income.
- Risk – Not paying capital gains taxes could result in IRS collection actions.
- Tips for success – The best way to avoid an unexpected capital gains tax bill is to plan for them and consult with a tax planning professional.
What Are Capital Gains Taxes?
Capital gains taxes are taxes on the profit made on the sale of almost any type of property, whether it’s the sale of investments or property for business or personal use. This means if you profit from the sale of stocks, bonds, furniture, cryptocurrency, your home, or a business, that profit could potentially be taxable as a capital gain.
There are two key points about capital gains taxes to remember. First, you’re only taxed on capital gains, not capital losses or the overall sale price. If you bought stocks for $1,000 and later sold them for $1,500, you’re not taxed on $1,500. Instead, any capital gains tax would apply to the $500 in profit that your furniture sale generated. Second, capital gains taxes only apply to realized gains. This means you don’t owe capital gains taxes on the appreciation of property until you sell it.
For example, let’s say you buy 10 shares of Acme Corporation at $100.00 per share. Sometime later it becomes worth $200.00 per share. You have an unrealized gain of $1,000.00 (10 shares x $100.00 per share of increased value), but don’t owe any capital gains taxes until you sell those shares.
Another factor to consider is how long you owned the asset before selling it. Generally speaking, if you hold on to the property for more than one year before selling it for a profit, it results in a long-term capital gain. If you held on to the property for one year or less, then it’s a short-term capital gain. This distinction matters because long-term capital gains are usually taxed at a lower rate than short-term capital gains.
As for when you pay your capital gains taxes (assuming you owe them), you’ll probably either pay the taxes quarterly or when you file your income tax return for the year. You’ll want to consult with your tax professional to confirm if you need to make quarterly estimated tax payments, but this can happen if you’re self-employed or have significant income subject to the capital gains tax.
Capital Gains Tax Rates for 2024
Your capital gains tax rate primarily depends on whether it’s a long-term or short-term gain and how much money you earn. If you have short-term capital gains, they will be taxed at the same rate as your ordinary income. If you have long-term capital gains, their tax rate depends on how much you make, but will usually be either 0%, 15%, or 20%.
Your long-term capital gains tax rate will be 0% if your taxable income is less than or equal to:
- $47,025 (for single and married filing separately taxpayers).
- $94,050 (for married filing jointly and qualifying surviving spouse taxpayers).
- $63,000 (for taxpayers filing as head of household).
Your long-term capital gains tax rate will be 15% if your taxable income is:
- More than $47,025, but less than or equal to $518,900 (for single taxpayers).
- More than $47,025, but less than or equal to $291,850 (for married filing separately taxpayers).
- More than $94,050, but less than or equal to $583,750 (for married filing jointly and qualifying surviving spouse taxpayers).
- More than $63,000, but less than or equal to $551,350 (for filing as head of household taxpayers).
Your long-term capital gains tax rate will be 20% if your taxable income exceeds the applicable 15% capital gains tax rate income thresholds. Your capital gains tax rate could be 25% or 28% in certain situations, such as selling collectibles or certain types of real property or small business stock.
Finally, there’s an additional 3.8% tax called the NIIT, or net investment income tax. You’ll likely have to pay the NIIT if you have short-term or long-term capital gains and your modified adjusted gross income (MAGI) exceeds the following thresholds:
- $200,000 (for single and head of household taxpayers).
- $250,000 (for married filing jointly and qualified widow(er) with dependent child taxpayers).
- $125,000 (for married filing separately taxpayers).
Why Taxpayers Sometimes Have Trouble Paying Their Capital Gains Taxes
Most taxpayers who struggle to pay their capital gains taxes usually do so for one of two main reasons. One, they’re unaware of the capital gains tax when completing the sale of property. Two, they had to sell one or more assets unexpectedly or were somehow forced to do so. Further discussion about reasons that lead to unexpected capital gains tax bills can be found below.
Selling Property to Pay for a Significant Expense
Life is full of unexpected events, and these events unfortunately often cost significant money. Maybe you had a large medical bill that was only partially covered by your health insurance and sold your vacation home that had appreciated in value. Or perhaps you lost your job and had to sell some stocks in your investment account to pay for a few months’ worth of living expenses. This latter situation often comes up when liquidating retirement accounts such as an IRS or 401(k) ahead of schedule. The capital gains tax burden is often amplified in these situations because of an early withdrawal penalty of 10%.
Selling Property to Cash In On Gains
Recall that a property appreciating in value (like a piece of real estate or stock) isn’t subject to capital gains tax until you sell the property. If you were looking to turn your “paper” gains into tangible cash, it’s possible you were more focused on what you were going to do with the money and might have forgotten to set aside the 15% or more of the profit for tax purposes.
Liquidating Inherited Assets
If you inherit non-cash property of significant value, it’s understandable if you sell the property to obtain cash that you can use. Even if you sell the property soon after inheriting it, you might still have a capital gains tax because the property might have had a quick jump in value right after the death of the person who gave you the property.
Note that inherited assets enjoy a step-up basis. As indicated above, when you sell an asset, you subtract the sales price from the price you paid when you bought it to calculate your profits. However, with inherited assets, you don’t use the original purchase price. Instead, you use the value of the asset on the day you inherited it.
Say your parents bought a home for $30,000 in 1970. If they sold it while living, they would use that number (plus the cost of any major upgrades) as their basis. However, if they both die and you inherit the property in 2024 when it’s worth $600,000, that becomes your basis.
What Happens If You Don’t Pay Capital Gains Taxes?
If you don’t pay your capital gains taxes, they’ll be treated like any other unpaid taxes with the IRS. So in addition to the tax itself, you could find yourself subject to penalties and interest.
Specifically, you can expect a failure-to-pay penalty, which is 0.5% of the unpaid tax for each month it goes unpaid. This penalty won’t exceed 25% of the unpaid tax, though. There may also be interest on the unpaid taxes plus penalties.
The IRS will also send you a tax bill and a series of letters and notices about the unpaid tax. Ignoring them and not reaching out to the IRS to pay the tax bill (immediately in full or with payments over time) can result in the IRS taking collection actions against you, including filing a lien or levying your property.
It’s understandable if you don’t have the cash to pay your capital gains taxes quickly, but you can make arrangements with the IRS to pay your taxes over time. There are short-term payment plans and long-term installment agreements available. Depending on the size of your tax debt, you can have 180 days to 72 months to pay off your tax balance.
In some situations, the IRS may be willing to reduce some of your tax liability. For instance, there’s an offer in compromise (OIC) available if you can demonstrate significant financial hardship or legitimately challenge the legal basis of the tax debt. If you’ve normally been good about paying your taxes on time or there are extenuating circumstances (like a natural disaster) for not paying your capital gains taxes, penalty abatement might be an option.
There’s also Currently Not Collectible (CNC) Status. This is where the IRS agrees to temporarily hold off on trying to collect an unpaid tax bill because doing so would place severe financial hardship on you. Worded differently, the IRS pauses its collection efforts because you don’t have enough money to pay for basic living essentials and your taxes. As nice as it is to obtain CNC Status to get the IRS off your back for a while, interest and penalties will continue to accrue.
Preventing an Unexpected Capital Gains Tax Bill
The best way to deal with a surprise capital gains tax bill is to avoid it altogether or plan for it. You can do this by consulting with a tax planning professional before selling an asset of notable value. They can warn you about the tax implications you didn’t know about or help you deal with capital gains taxes you’re trying to manage.
For example, let’s say you want to sell your primary residence that has appreciated significantly in value since you first purchased it a few years ago. There’s an exclusion that typically allows you to exclude up to $250,000 of the gain ($500,000 if married filing jointly) received in the sale of your home.
To qualify, you need to have owned and used your home for at least two out of the five years before selling your home. Talking to a tax professional can confirm whether or not you meet the eligibility requirements for this exclusion. And if you don’t, they can advise you on what you need to do to qualify. In some cases, it might be as simple as delaying the closing date of your home’s sale by a few weeks or months.
A tax planner can also help you with ways to increase the cost basis of property. As a result, when you sell the property, you’ll have a smaller realized gain, at least from the IRS’ perspective. One way to increase the cost basis is to keep track of the capital expenses you’ve incurred while owning the property – for example, new roofs, HVAC systems, or other major upgrades. This is particularly relevant to real estate.
Another way to reduce your capital gains taxes is to hold on to the property longer before selling it. This could mean the difference between paying 0% or your ordinary income tax bracket rate.
Consider tax loss harvesting. This is where you sell losing investments and use their realized losses to offset your investment gains. In situations where your capital losses exceed your capital gains, you can carry over up to $3,000 to offset gains in future years.
Finally, when selling an asset that results in capital gains, set aside enough money to cover the capital gains tax. If you’re not sure how much the applicable tax rate will be, set aside at least 20% (or consult with your tax planning professional).
The W Tax Group Can Help With Capital Gains Taxes
Capital gains taxes are one of the more frustrating taxes to deal with, but there are ways to reduce or avoid them. However, if it’s too late for either of those options and you now have an unexpected tax bill you can’t afford to pay, get in touch with the W Tax Group. We can examine your tax case and explain what your best course of action is. To schedule a free consultation, use our online contact form.
