Capital Gains and How Are They Taxed
The Basics of Capital Gains
The term capital gain, or capital gains, is used to describe the profit earned from buying an investment or other asset at one price and selling it at a different, higher price. For instance, if you bought a piece of real estate for $500,000 and sold it for $800,000, you would need to report total capital gains of $300,000 ($800,000 selling price - $500,000 cost basis = $300,000 capital gains profit).
Capital gains aren't limited to stocks, bonds, mutual funds. They can also apply to works of art, real estate, vehicles, baseball cards, bottles of wine, silver coins, rare postage stamps, or virtually anything else that can be considered an investment.
Taxation of Capital Gains
The tax rules for capital gains vary depending upon the specific investment, the length of time the asset was held, as well as your personal income tax rate. For instance, capital gains on gold or silver is taxed as a collectible, which has a higher rate (28% at the time of publication) than capital gains on stocks (15% for long-term holdings that are sold). There are generally three considerations when it comes to determining the tax treatment of your capital gains. These are:
- What is the tax treatment for the underlying asset on capital gains? As mentioned earlier, gold and silver capital gains are taxed at higher rates than the capital gains paid on stocks or bonds. Likewise, the tax rules provide huge lifetime capital gains exemptions for homeowners that sell their house at a profit (which is technically a capital gains profit because it comes from selling an asset that was purchased at a lower price). We talked about this in-depth in Capital Gains Tax Holding Periods, which provided you with examples and more information on how the length of time you hold an investment can determine, in part, the total capital gains taxes that will be assessed.
- What is the capital gains tax holding period? It is the length of time you held the investment. According to the IRS, the clock begins the day you purchase your investment and ends the day you sell it. To encourage long-term investing, the government often provides lower tax rates on assets that are held longer than a certain period of time such as 1 year or 5 years. These are taxed as long-term capital gains. Investments that are held and sold within 365 days or less are considered short-term holdings and any gains will be taxed at the taxpayer's ordinary income rate. For example, your wages and earnings are taxed at 28%. On January 1, you purchase 100 shares of Coca-Cola for $5,000, then sell them four months later on April 1 at $5,500. Since you sold them at a price higher than your purchase price or cost basis, you will have made $500 and incur a capital gains tax. However, because you did not hold the shares of stock for longer than 1 year, you will pay a higher capital gains tax rate that will be equal to your personal income tax rate of 28% instead of the long-term capital gains tax rate of 15% or less.
- Are the capital gains being offset by capital losses? Capital losses are the opposite of capital gains - instead of selling your investment for a profit; you sell them at a loss. Most of the time, you can offset any capital gains taxes you would owe by deducting capital losses on similar investments. For instance, if you had a $100,000 long-term capital gain on one stock and a $30,000 long-term capital loss on another stock, you might be able to pay taxes on the net capital gains of $70,000, saving you money. As of 2016, if you still have remaining losses after all other capital gains have been used to offset them, the IRS will allow you to deduct up to $3,000 from your taxable income (or $1,500 if you are married and filing separately). Then, if any losses remain after that, you will be able to apply them to the next year's tax return as carryover losses.
For more information, please visit www.IRS.gov, or consult with your accountant or IRS agent.