Capital gains tax is a tax on the profit that an individual or entity realizes from the sale of a capital asset, such as a piece of real estate, a stock, or a business. The tax is imposed on the difference between the asset's purchase price and its sale price, known as the capital gain.
There are two types of capital gains: short-term and long-term. Short-term capital gains are realized from the sale of an asset that was held for one year or less. Long-term capital gains are realized from the sale of an asset that was held for more than one year.
The tax rate applied to capital gains depends on the individual's tax bracket and the type of capital gain. For individuals in the highest tax bracket, the long-term capital gains tax rate is currently 20%, while the short-term capital gains tax rate is the same as the individual's ordinary income tax rate, which can be as high as 37%. For individuals in lower tax brackets, the long-term capital gains tax rate is generally lower, ranging from 0% to 15%.
There are a number of exclusions and exemptions to the capital gains tax. For example, the sale of a primary residence is generally excluded from capital gains tax if the individual has lived in the home for at least two of the past five years. Additionally, certain types of assets, such as collectibles and certain small business stock, are subject to a higher capital gains tax rate.
Capital gains tax can have a significant impact on an individual's overall tax liability. It is important for individuals to understand their capital gains tax obligations and to seek the advice of a tax professional when necessary.