Many people don't know as much about capital gains taxes as they think they do. What you're selling, how long you've owned it, and your total income all factor into how much capital gains tax you need to pay. As the year draws to a close, it's a good idea to review capital gains taxes. If you profit from selling a capital asset, such as stocks or real estate, you will likely need to pay capital gains tax. Here are ten things you should know about this type of tax:
You Must Sell an Asset to Know About a Capital Gain or Loss
Selling shares in your favorite company because you think that the stock price will rise before earnings are reported does not entitle you to a capital gain or loss. You only realize such a gain or loss if you actually sell your shares at a higher price than what you paid for them. The sale is important because it means giving up ownership of the asset and receiving cash, property, goods, or services in return. You have a capital gain if you sell the asset for more than your tax basis (the amount you paid for it, including any costs associated with buying and selling the asset). And you have a capital loss if you sell it for less than your tax basis. Only then can you claim some or all of that loss on your income tax return.
Capital Gain Is Taxed Differently Than Your Other Income
Like most people, much of the money you earn comes from your salary or hourly wage (ordinary income). This means that it is taxed at a similar rate to all others in your tax bracket, subject to various rules and limits. However, capital gains are taxed differently. They are subject to a special tax rate with fixed brackets, which is usually lower than your ordinary income tax rate. Your capital gain may also be shielded by other provisions available only to capital gains, such as the 0% and 15% rates for most long-term gains (more on that later).
You Report Capital Gains on Schedule D Of Your Tax Return
Schedule D reports your total taxable gains and losses from the sale of capital assets (stocks, real estate, collections, or other property that is not inventory) during the year. It also records the cumulative amount of these transactions since you started reporting them over the years. Some or all of your capital gains may be subject to the 0% and 15% rates for long-term gains. If these lower rates apply, they will reduce your taxable income for this year and shield your investment income from being taxed at a higher rate.
Capital Loss Offsets Capital Gain
If you have a net capital loss after offsetting it with capital gains, you can deduct up to $3,000 of such loss from your ordinary income. The remainder is carried over and applied to next year's capital gains and unallowed losses from previous years.
There Are Two Types of Capital Gains: Short-Term and Long-Term
Short-term capital gain (or loss) applies to assets that were held for one year or less before you sold them. This includes all property other than collectibles and specific depreciated real estate (such as land). Short-term gains are considered ordinary income and taxed at your marginal tax rate, which is the rate you pay on the last dollar you earn each year.
Long-term capital gain (or loss) applies to assets you held for more than one year before selling them. Collectibles depreciated real estate and other properties are also considered long-term if they are held for more than a year. The tax rate is either 0%, 15%, or 20% for these investments. Long-term gains on most other assets are taxed at a special rate of 0% and 15%, except for those held in tax-deferred accounts. These include:
If you're in the 10%- or 15%-income tax bracket, then your long-term capital gain is capped at this lower rate. If you're not entitled to the full benefit of the 0% and 15% rates, then your taxes on these investments may be higher.
You Have to Report All Capital Gains, Even Those You Do Not Receive Cash For
You must include a total taxable amount for any property "returned" to you. This happens when your broker initiates a margin call -- basically, it's a demand for additional funds to meet minimum margin requirements. You must also report the return of property that you deposited as collateral.
Capital Losses Offset Ordinary Income Up To $3,000 Each Year
If you have more capital gains tax than capital losses, any excess gains are considered long-term if you held your assets for more than one year. You can offset this amount with capital losses on other investments, up to a maximum of $3,000 each year.
There Are Some Exceptions to The Rules About Long-Term Gains
Additional tax breaks for certain types of assets allow you to avoid paying ordinary income tax rates on your capital gains. These include:
The first two of these limitations apply to gains from real estate, and the third applies to both the rental property and business capital. You must have held your securities for more than a year for them to qualify as long-term gains. The holding period is one year for many joint investments such as stocks and mutual funds. However, if you purchased the asset on any day other than the date of sale, then you need to hold it for more than a year. The clock starts the day after you acquired the security, not when you paid for it.
Remember to consider capital gains tax before making investment choices rather than simply after realized. Before investing, you should know the kind of investment, the holding period, and the tax consequences. By understanding where and how your earnings are derived, you can maximize your profits while minimizing your tax liability and increasing your profits.