Capital gains tax is imposed on the gain from the sale of a capital asset. By definition, capital assets are real or personal property such as real estate, stocks, bonds, and mutual funds (additional items may qualify but are beyond the scope of this article.)

Capital gains are grouped and taxed based on the holding period. Long-term capital gains or losses are generated by the sale of assets held over 12 months, and short-term have a holding period of 12 months or less. This character is maintained with a pass-through entity. A mutual fund may distribute long-term gains to you.

All capital asset gains/losses are grouped into short- and long-term ones. It doesn’t matter if you generate a long-term gain selling stocks or land; they are reported together:

• Short-term capital gains and losses are netted. Carryover of any short-term losses from a prior year is first applied to short-term gains, if any.
• If you have net short-term losses, they are applied against net long-term gains.
• Net short-term gains after netting against long-term losses are taxed at ordinary income rates.
• If the result is net long-term gains, that amount is taxed at capital gains rates.
• What happens if the net short-term and long-term is a loss? Individuals can use only $3,000 to offset ordinary income. The remaining loss is carried over to the next year. Note: Alabama has no such limitation, and all net losses can be applied to other income.

OK, let’s run through a couple of examples.

• In 2024, Rusty had $150,000 of ordinary income along with net short-term capital losses of $10,000 and net long-term capital gains of $15,000. After netting, Rusty’s capital gains are $5,000 (long-term) and taxed at capital gains rates.
• Mary had $75,000 of W-2 income, along with $5,000 of short-term capital losses and $3,000 of net long-term losses. Her total capital losses are $8,000. She can use $3,000 against ordinary income, and the remainder is carried forward.

WHAT DO I PAY ON CAPITAL GAINS?

Federal

The special income tax rates on qualified dividends and long-term capital gains range from 0% to 20%. In 2024, the rate is 0% for certain individuals with taxable income below $94,050 (married filing jointly) or $47,025 (single). That’s right, a married couple could have $94,000 of income (including capital gains) and pay $0 of Federal income tax. The rate increases to 15% for those with taxable income above the 0% threshold but below $583,750 (married filing jointly) or $518,900 (single). Capital gains for those with income above the 15% threshold are taxed at 20%.

The above rates do not apply to collectibles such as art, coins, and antiques, which are taxed at a maximum rate of 28%. It is best to understand the consequences before initiating a significant sale.

Planning Tip: It may be advantageous to gift stock with built-in long-term gain to an adult child in the 0% capital gains bracket and let them sell. Make certain to consider if kiddie tax is an issue.  

Short-term capital gains are taxed at ordinary income rates – like interest, W-2 income, and nonqualified dividends.

Net Investment Income tax (NIIT) is a 3.8% additional Medicare surtax. This applies to married filing jointly taxpayers with taxable income over $250,000 (single, $200,000). The tax applies to passive income like interest, dividends, rents, capital gains, and income from passive activities.

So, for federal purposes, the maximum rate applied to capital gains is 23.8% – 20% plus the 3.8% surtax.

Alabama 

Alabama, like many states, has no special capital gains rate. Capital gains are taxed at 5%, like any other income.

Planning Tip: Consider using long-term gain property for charitable contributions.  You get a charitable deduction for the fair market value and avoid capital gains. You must itemize to benefit.   

Beware wash sales

If you sell a security at a loss and repurchase the same security within 30 days, the loss is disallowed and moved to the basis of the new purchase.

Estates and Trusts

Estates and trusts follow a very similar set of rules, although the income levels are much lower.

As always, contact your Dent Moses advisor if you have specific questions. We are here to help.