While many investors were drooling over Tesla (NASDAQ:TSLA) shares in 2020, NIO (NYSE:NIO) was behind the scenes making tremendous gains that led to mega profits. Shares of the Chinese electric car maker surged over 1,000% this year, continuing its upward momentum as the most recent earnings report beat Wall Street's estimates.

If the urge to turn those unrealized gains into pocketable profits caused you to sell shares of NIO, you should start thinking about capital gains taxes now. It's best never to be surprised during tax time. 

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Cashing in on profits can be taxing 

With the stock market reaching all-time highs, you're probably enjoying the big boost in share prices while shamelessly relegating all tax talk to the back burner. But all investors should remember this: selling stock in a standard brokerage account is a taxable event. This extra income -- although unearned -- will put you in the league of capital gains taxes. 

Capital gains are great rewards -- they mean you've made some money in the stock market. When you sell a stock for more than you purchased it for, you have a capital gain. Let's say you purchased 1000 shares of NIO stock for $4 per share and sold all your shares for $50,000. That's a $46,000 capital gain

The taxes you pay are based on the time period you held the stock in your account. If you held your investment for a year or less, you pay a short-term capital gains rate -- the same rates you pay on the wages you earn from working a job. For example, if you bought shares of Tesla in March and sold in September of the same year, your short-term capital gains will be included in your ordinary income. Short-term capital gains will be taxed at the rates below, climbing as high as 37% if you fall within the highest taxable income range.  

2020 tax brackets

Below are the federal tax brackets for taxes due by April 2021, for the taxable income you earned in 2020.

Tax Rate 

Single Filers

Married Filing Jointly or Qualified Widow

Heads of Household

Married Filing Separately

10%

$0 to $9,875

$0 to $19,750

$0 to $14,100

$0 to $9,875

12%

$9,876 to $40,125

$19,751 to $80,250

$14,101 to $53,700

$9,876 to $40,125

22%

$40,126 to $85,525

$80,251 to $171,050

$53,701 to $85,500

$40,126 to $85,525

24%

$85,526 to $163,300

$171,051 to $326,600

$85,501 to $163,300

$85,526 to $163,300

32%

$163,301 to $207,350

$326,601 to $414,700

$163,301 to $207,350

$163,301 to $207,350

35%

$207,351 to $518,400

$414,701 to $622,050

$207,351 to $518,400

$207,351 to $311,025

37%

$518,401 or more

$622,051 or more

$518,401 or more

$311,026 or more

Data source: IRS.

A long-term strategy can save you money

If you've held your investments for over a year, the IRS will reward you with lower long-term capital gains tax rates of 0%, 15%, or 20% based on your taxable income for the year. For 2020, you can completely bypass taxes on capital gains if your income is $40,000 or less (single filers) or $80,000 or less (married filers). You can also plan ahead for 2021 by keeping in mind that the income amounts for long-term capital gains have increased up to $40,400 for single filers or up to $80,800 for married filers. 

If you experienced a decrease in income during the pandemic, the bright side is that you may be eligible to cash in on NIO's meteoric rise without paying taxes on your profits if your income falls within the 0% tax bracket! There's always a way to turn pain into possibilities when you have a long-term outlook. 

Taxes don't have to be a nightmare 

Now that you've earned money in the stock market, you'll have a chance to brag about your capital gains on your tax return. Download Form 8949-Sales and Other Dispositions of Capital Assets to report your short- and long-term stock transactions for the year.

Fortunately, your brokerage handles most of the hard work for you. They'll send you a Form 1099-B that covers all the pertinent stock information you'll need to complete Form 8949 for the IRS. That frees you up to focus more on the exciting stuff -- finding the highest-growth stocks to fund a relaxing retirement and ensuring you hold them for a full year to score the best returns.

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.