If you’ve ever owned – and then sold – an investment asset for profit, you likely paid taxes on those gains. At the federal level, those gains will either be taxed at your ordinary income rate (for short-term holds of less than one year) or at the capital gains rate (for long-term holds of more than one year).
But are those capital gains taxed twice? It depends. When it comes to traditional asset investments (such as stocks), proceeds from the sale can be taxed twice, once at the corporate level and again at the personal level.
Then there are capital gains at the state level. And this is where things can get a little trickier.
The Capital Gains Explanation -- Nationally
According to the IRS, capital gains occur if you sell an asset for more than that asset’s adjusted basis. The adjusted basis is described as what you originally paid for the asset, plus improvements, additions, or depreciation incurred while you own the asset. Capital gains taxes are paid for the year during which they are realized. In other words, when you receive the profits from the sale, you pay the tax.
As mentioned above, those capital gains will either be defined as short-term or long-term, depending on how long you owned the asset. In most cases, a longer-term hold is more advantageous, as the tax rate can be lower, depending on your tax bracket.
Trying to Localize
There are 50 states in America, in addition to the District of Columbia. And each of these states has its own method when it comes to taxing capital gains. For instance:
- Many states tax capital gains as income; this applies to long- and short-term capital gains.
- Some states don’t levy a capital gains tax – think Texas, Florida, and Nevada, among others. These states also don’t tax personal income on wages, but might tax investment interest and dividends.
- States also have special rules applying to the sale of certain assets, such as exclusions for collectibles purchased prior to a specific year.
Furthermore, capital gains tax rates vary by state. They can range from 0% (Alaska, Florida, and Texas) to 13.3% (California). Then there are states – like Hawaii – that tax capital gains at a lower rate than ordinary income.
And Vermont residents may be allowed to deduct 40% of their capital gains on long-term assets held over three years at a maximum of $350,000, as long as that amount doesn’t exceed 40% of federal taxable income.
Think Before Filing
Capital gains taxes are an important part of understanding investment strategy. While the federal rules regarding these taxes are fairly straightforward, these regulations vary a great deal based on where you live. As always, it’s a good idea to check with a tax advisor who understands state tax rules when it comes time to file your taxes.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
FAQs
The taxation of capital gains places a double tax on corporate income. Before shareholders face taxes, the business first faces the corporate income tax.
What is the 2 of 5 rule for capital gains? ›
When selling a primary residence property, capital gains from the sale can be deducted from the seller's owed taxes if the seller has lived in the property themselves for at least 2 of the previous 5 years leading up to the sale. That is the 2-out-of-5-years rule, in short.
How to avoid double taxation on capital gains? ›
How to Avoid Double Taxation
- Retaining corporate earnings. You can avoid double taxation by keeping profits in the business rather than distributing it to shareholders as dividends. ...
- Pay salaries instead of dividends. You can distribute profit as salaries or bonuses instead of as dividends. ...
- Split income.
Opponents of double taxation on corporate earnings contend that the practice is both unfair and inefficient, since it treats corporate income differently than other forms of income and encourages companies to finance themselves with debt, which is tax deductible, and to retain profits rather than pass them on to ...
Why is some income from capital taxed twice? ›
So if you're a shareholder or owner of a corporation, then you may face double taxation because your income will come from corporate earnings that were already taxed, and you will also pay taxes on them. The same happens to individual investors who pay taxes on dividends, which are a share of a corporation's earnings.
Why are we taxed twice? ›
The term "double taxing" is most commonly used to reference the combination of corporate income tax and dividends tax. The basic argument is that the tax code places a levy against the income of a corporation, and once again when that income is distributed to shareholders in the form of dividends.
At what age do you not pay capital gains? ›
Since the tax break for over 55s selling property was dropped in 1997, there is no capital gains tax exemption for seniors. This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
How many years to avoid capital gains? ›
The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify. The seller must not have sold a home in the last two years and claimed the capital gains tax exclusion.
Are there any loopholes for capital gains tax? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
What is a simple trick for avoiding capital gains tax? ›
Hold onto taxable assets for the long term.
The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.
Examples of Double Taxation
The United States' tax code places a double-tax on corporate income with one tax at the corporate level through the corporate income tax and a second tax at the individual level through the individual income tax on dividends and capital gains.
Who avoids double taxation? ›
Two business structures are often preferred for small businesses since they avoid this double taxation burden. These are an LLC and an S Corporation.
Who suffers from double taxation? ›
Most commonly, double taxation happens when a company earns a profit in the form of dividends. The company pays the taxes on its annual profits first. Then, after the company pays its dividends to shareholders, shareholders pay a second tax.
Is double taxation illegal in the US? ›
Contrary to popular belief, there's nothing in the U.S. Constitution or federal law that prohibits multiple states from collecting tax on the same income. Although many states provide tax credits to prevent double taxation, those credits are sometimes unavailable.
Do you pay both state and federal taxes on capital gains? ›
Capital gains are taxable at both the federal level and the state level.
Are capital gains added to your total income and put you in a higher tax bracket? ›
Long-term capital gains can't push you into a higher tax bracket, but short-term capital gains can. Understanding how capital gains work could help you avoid unintended tax consequences. If you're seeing significant growth in your investments, you may want to consult a financial advisor.
Do you have to wait 2 years to avoid capital gains? ›
The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify. The seller must not have sold a home in the last two years and claimed the capital gains tax exclusion.
Is capital gains one year or two? ›
Short-term capital gains tax is a tax applied to profits from selling an asset you've held for less than a year. Short-term capital gains taxes are paid at the same rate as you'd pay on your ordinary income, such as wages from a job. Long-term capital gains tax is a tax applied to assets held for more than a year.
If you’ve ever owned – and then sold – an investment asset for profit, you likely paid taxes on those gains. At the federal level, those gains will either be taxed at your ordinary income rate (for short-term holds of less than one year) or at the capital gains rate (for long-term holds of more than one year).