When do British investors pay Capital Gains Tax in the United States?


Simon Misiewicz

4th August 2021

The frequently asked questions about paying capital gains tax in the United States as a British investor

As property accountants, we are regularly asked about capital gains tax. We will look to answer the below questions in this Article.

“Are you paying too much capital gains tax?”

“What is capital gains tax?”

“What is the difference between short-term and long-term capital gains tax?”

“How are capital gains calculated?”

“What are capital gains rule exceptions?”

“How is Net Income Investment Tax (NIIT) relevant to capital gains?”

“What are the 2021 capital gains tax rates?”

“Can I avoid capital gains tax by buying another house?”

“What is tax-loss harvesting?”

“Can I minimize capital gains tax?”

“How does this affect our UK readers?”

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Are you paying too much capital gains tax in the United States as a British investor?

As US/UK ex-pat tax experts, we know that many of our clients find capital gains tax a complicated subject.

There are many pitfalls for the unwary, and unless armed with the latest expert tax knowledge, it can lead to costly mistakes.

Capital gains tax laws specific to the USA require experienced and trusted tax accountancy assistance.

There are many reasons why people British people living in the United States pay far more tax than they need. This is because:

-They do not know what they do not know.

-They have not spoken to a tax specialist that knows all the UK and US tax laws.

-Their accountants in the UK are not knowledgeable about the US tax laws under the IRS.

-Their CPAs are not knowledgeable when it comes to the UK tax laws under HMRC.

Have a question about property investments, tax or being an expat?

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What is capital gains tax in the United States?

Capital gains tax in the United States payable to The IRS is a tax applied to the profits made from the sale of an asset.

Capital gains tax is only payable once the asset has been sold. The level of capital gains tax paid depends on different factors, including income level, marital status, income tax bracket and cost basis of the asset.

It is a tax on the increase in value of investments realised when individuals or corporations sell those investments.

Capital gains tax does not apply to an unsold investment.

Stock shares that appreciate in value annually would not incur capital gains tax until sold.

The IRS classifies capital gains as profits from the sale of an asset.

The asset could be shares of stock, a piece of land, or a business and are classified as taxable income.

The amount of capital gains tax paid varies depending on how long the investment has been held for.

Short-term capital gains and long-term capital gains are taxed at different rates.

The amount of capital gains tax paid to the IRS depends on three main factors: the size of the gain, your income tax bracket, and how long you have held the asset.

Some industry commentators claim that capital gains taxes are paid disproportionately by high-income US households as they are more likely to possess assets that generate taxable gains.

It has also been argued that those who pay capital gains tax in the US have more ability to pay.

This also means that capital gains tax payment can more easily be deferred or avoided by these high-income investors as it only becomes due if and when the owner sells the asset.

Taxable capital gains can also be reduced for a year by the number of capital losses incurred over the same period.

A capital loss occurs when an owner sells an investment for less than it was purchased.

The total of long-term capital gains minus any capital losses is called the ‘net capital gain’, which is the amount that capital gains taxes are assessed on.

Capital gains tax only applies to capital assets, including stocks, bonds, jewellery, coin collections and real estate property.

Taxpayers can use different strategies to offset capital gains with capital losses to lower their capital gains tax liability. This article will highlight these strategies further.

The IRS has clear guidelines on capital gains tax which are worth reviewing.

What is the difference between short-term and long-term?

Short-term capital gains tax is a tax on profits from the sale of an asset held for one year or less.

The short-term capital gains tax rate equals an individual’s income tax bracket.

Long-term capital gains tax is a tax on profits from the sale of an asset held for over a year.

The long-term capital gains tax rate is 0%, 15% or 20%, depending on your taxable income and are generally lower than short-term capital gains tax rates.

Your tax rate for long-term capital gains could be 0%, depending on your regular income tax bracket.

Taxpayers in the highest income tax bracket pay long-term capital gains rates that can be up to 50% lower than their income tax rates charged on their ordinary income.

How is capital gains calculated by The IRS in the United States?

Capital losses can be deducted from capital gains to reduce any taxable gains for the year.

The calculations can be complex if you’ve incurred capital gains and capital losses on both short-term and long-term investment during the same period.

Short-term gains are netted against short-term losses to produce a net short-term gain or loss.

The same is done with long-term gains and losses.

These numbers for short-term and long-term are reconciled to produce a final net capital gain or loss, filed on the tax return.

What are the exceptions?

Some types of assets get different capital gains tax treatment. These include:

– Collectables – gains on collectables such as art, antiques, jewellery, precious metals, coins, and stamp collections are taxed at 28% by the IRS regardless of your income.

– Owner-occupied real estate – real estate capital gains are taxed differently if you’re selling your main residence.

As long as the owner has lived in the property for two years, $250,000 of an individual’s capital gains on the sale of a home are excluded. This exclusion is $500,000 for those married and filing jointly.

Capital losses from the sale of personal property such as a home are not deductible from gains.

Investors who own real estate can take depreciation deductions against income to reflect the deterioration of a property as it ages. This is a great way to reduce your annual property taxes incurred on your rental income.

Any depreciation deduction essentially reduces the amount the investor is considered to have aid for that property originally.

That can increase the taxable capital gain when the property is sold.

This is because the gap between the property’s value after deductions and the sale price will be greater.

Non-resident aliens are also exempt from capital gains tax in the US.

This is an important exemption and is worth bearing in mind when investing.

Make sure you research how the IRS taxes non-resident aliens

How is Net Income Investment Tax (NIIT) relevant to capital gains?

If your income in the United States is high, you may become subject to Net Income Investment Tax (NIIT).

This additional tax imposes an additional 3.8% on investment income, including capital gains, if your modified adjusted gross income exceeds certain levels.

At the time of writing, those levels are $250,000 if married and filing jointly, $200,000 if single or the head of a household, and $125,000 if married and filing separately.

What are the 2021 capital gains tax rates in the United States?

Capital gains tax rates depend on whether the asset was held for more or less than one year, as highlighted in this article.

If the asset is held for over a year, then the capital gain will be taxed at 0%, 15% or 20% depending on the overall income level of the investor.

Can I avoid US Capital Gains Tax by buying another house?

If you purchase a second home and start using it as a primary residence, you will still need to meet the residency rule to qualify for the exemption. Namely, you would have needed to have owned the property for two years.

There is also the two out of five-year rule, which means that you can live in a house for a year, rent it out for three years, then move back into it for 12 months.

The IRS will then concur that the home qualifies as your principal residence.

There is also the opportunity of investing the money you have obtained into another real estate investment. There is the ability to use a 1031 exchange. This process allows you to reinvest the money received from the property and reinvest it. The capital gains are then rolled over until you sell the newly purchased property.

What is tax-loss harvesting?

Tax-loss harvesting involves selling an investment that has lost value, replacing it with a similar investment, then using the investment sold at a loss to offset any gains.

Tax-loss harvesting is a smart way to avoid paying capital gains tax.

The money lost on an investment can offset capital gains on other investments.

Investors can write off losses when selling a depreciated asset, cancelling some or all of the capital gains made on appreciated assets.

This strategy can help to reduce the amount of capital gains tax paid, although as an investment strategy, it is focused on a short-term tax break rather than on long-term considerations.

Can I minimize capital gains tax?

The simple answer to this would be to hold assets and investments for more than a year before selling them. Did you know that you do not pay Capital Gains Tax if you refinance your real estate property? This might be a better way to pull money out of your investment rather than paying Capital Gains Tax.

The tax paid on long-term capital gains is generally lower than for short-term gains. Holding an asset or investment for 12 months or longer significant tax savings can be made on capital gains.

An investor could also utilize losses incurred on previous investments to offset their tax bill in the current year.

Excluding home sales is a good way to minimise capital gains tax.

If the main residence has been owned for at least two years in the five-year period before it is sold, then capital gains of up to $250,000 can be excluded from a home sale if single, and up to $500,000 if married and filing jointly.

Avoid property tax using tax-efficient investment structures

Investing in tax-advantaged accounts such as 401(k) plans, individual retirement accounts and 529 college savings accounts allows investments to grow tax-free or tax-deferred.

You do not have to pay capital gains tax if selling investments within these accounts.

Roth IRAs and 529s provide big tax advantages because you do not pay any tax on investment earnings.

It is also worth considering waiting until retirement to sell profitable assets.

The capital gains tax bill could be reduced if your retirement income is low enough.

It could even mean that you avoid paying any capital gains tax at all.

Bear in mind that an asset or investment must be sold after a year’s holding for the sale to qualify for treatment as a long-term capital gain.

To minimize capital gains tax, book a call with a capital gains tax expert today to start saving money.

How does this affect our UK readers?

You need to be aware that you will pay US Capital Gains Tax to the IRS. However, if you are a UK resident and UK domiciled, you will have to pay UK Capital Gains Tax to HMRC as you have sold a foreign asset. You will receive a tax credit from the IRS to lower your UK Capital Gains Tax liability.

You may be interested in services where we help Americans move to the UK with tax in mind. There are a number of legal matters and tax issues that you need to consider. We have also written a useful article about people moving from the US to the UK and getting a VISA.

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