Capital gains are the profits made from the sale or trade of real estate, businesses, or any investment in which profits are realized over the original purchase price. It is your responsibility to pay taxes on such gains, just as you pay taxes on other income.
Capital gains taxes are paid on the sale of mutual funds, stocks, bonds, real estate, and the early withdrawal of funds from retirement accounts such as 401k, Keogh, and SEP plans.
Both the Internal Revenue Service (IRS) and the state may tax you on capital gains income. Lower taxes are paid on gains for investments held for longer periods of time, over a year, than on short term investments, those held for under 12 months.
Each income tax bracket is given a marginal tax rate percentage figure. A taxpayer may fall in either the 10%, 15%, 25%, 28%, 33%, 35% or higher tax brackets.
Long term capital gains, investments that are held for over a year, are taxed on a rate that is 20 percent or less, and somewhat lower for investors in the botton 10 to 15 percent federal tax brackets.
Short term capital gains are taxed as ordinary income, depending on the filer's personal income. These gains are made on investments that are held for less than a year and are taxed at normal rates.
Gains, whether long term or short term, are taxed at a rate depending on the amount of income they generate and whether you are filing single, married, filing jointly or separately, or filing as the head of the household.
There are ways to limit the amount of taxes paid on capital gains.
•Invest in real estate, as long as you abide by applicable tax laws, both federal and state. You can roll your capital gains over and over again by investing in like kind or more expensive properties.
•Invest in tax free money market funds, stocks, bonds, or other securities that produce lower capital gains distributions.
•Make donations to charities in the form of appriciated securities, charitiable gift mutual funds, or charitable annuities.
•Open tax deferred retirement accounts such as 401ks, IRAs, Roth IRAs, SEP Plans, or other tax deferred investment vehicles.
There are many ways to offset capital gains taxes but you should know what you are doing before getting started because complications may arise if it is not done according to the laws that govern taxation.
As with all issues dealing with taxes, if you are not up to speed on the latest tax laws, you should consult a tax specialist, a CPA, or an attorney who specialize in tax laws.