A capital gains tax is an income tax the IRS imposes on proceeds from a sale of an asset. Basically, a capital gain is the difference between what you paid for an asset and the amount of the subsequent sale. The assets targeted for a tax on capital gains are capital assets like stocks, bonds, jewelry, a coin collection, and your home.
Exempted from capital gains treatment—or so-called non-capital assets—are the products of your creativity and production. Examples would be artistic compositions, drawings, patents, and inventions.
What are Rates Dependent On?
Capital gains taxation rates on eligible assets depend on how long you have owned the item before you sell it:
- Short-term capital gains taxes are applied on the profits of a sale of an asset held for less than a year. The tax rates vary your ordinary income and are from 10% to a top rate of 37%. (Graduated rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%.)
- Long-term capital gains rates are lower and apply to assets you have held for more than one year. The basic capital gains rates are 0%, 15%, and 20%. Those three levels are based on your level of income. Most taxpayers are subject to the middle rate of 15%. If you earn more than $425,801 during a tax year, you can expect to pay the 20% long-term capital gains tax.
Selling a Home or Inherited Stocks
Two special capital gains tax situations are (1) profits on the sale of your home, and (2) the sale of inherited stocks:
Homeowners who have lived in their home continuously for two of the past five years can exempt $250,000 ($500,000 for joint filers) in profits from capital gains tax.
Stocks received as part of an inheritance are not taxed until they are sold. The capital gains taxation is based on either the fair market value of the stock at the time of the previous owner’s death or a date 6 months later. Whatever the stock earned in value between the original owner’s purchase and the death of the owner is not taxed.
Capital Loss Limits
So, the U.S. tax system definitely favors long-term investments. You will pay the lowest rate of capital gains tax if you hold on to the investment over a number of years. Likewise, you can use capital losses to offset any gains over time. However, you can only apply capital losses to the current tax year with an upper limit of $3,000 or the actual loss, whichever is less.
Note: You can carry a capital loss forward to subsequent tax years until all the loss is claimed.
Calculating and Reporting Capital Gains Income Can Get Complicated
You must report material capital gains to the IRS on a Schedule D form. It gets a bit complicated when you get into issues of realized and unrealized gain and reporting capital losses. Chandler & Knowles have the tax planning experts who can help you navigate the complicated personal and business tax rules. Contact us and learn more about our tax advisory services.