A capital gain occurs when you sell something for more than you spent to acquire it. This happens a lot with investments, but it also applies to personal property, such as a car. Every taxpayer should understand these basic facts about capital gains taxes.
Key Takeaways
- Capital gains tax may apply to any asset you sell, whether it is an investment or something for personal use.
- If you sell something for more than your "cost basis" of the item, then the difference is a capital gain, and you’ll need to report that gain on your taxes.
- Depending on the real estate market, you might realize a huge capital gain on a sale of your home. The tax code allows you to exclude some or all of such a gain from capital gains tax, as long as you meet certain requirements.
- How your gain is taxed depends on how long you owned the asset before selling—short-term gains are typically taxed at a higher rate than long-term gains.
Capital gains aren't just for rich people
Anyone who sells a capital asset should know that capital gains tax may apply. And as the Internal Revenue Service points out, just about everything you own qualifies as a capital asset. That's the case whether you bought it as an investment, such as stocks or property, or something for personal use, such as a car or a big-screen TV.
If you sell something for more than your "cost basis" of the item, then the difference is a capital gain, and you’ll need to report that gain on your taxes. Your cost basis is usually what you paid for the item. It includes not only the price of the item, but any other costs you had to pay to acquire it, including:
- Sales taxes, excise taxes and other taxes and fees
- Shipping and handling costs
- Installation and setup charges
In addition, money spent on improvements that increase the value of the asset—such as a new addition to a building—can be added to your cost basis. Depreciation of an asset can reduce your cost basis.
In most cases, your home has an exemption
The single biggest asset many people have is their home, and depending on the real estate market, a homeowner might realize a huge capital gain on a sale. The good news is that the tax code allows you to exclude some or all of such a gain from capital gains tax, as long as you meet all three conditions:
- You owned the home for a total of at least two years.
- You used the home as your primary residence for a total of at least two years in last five-years before the sale.
- You haven't excluded the gain from another home sale in the two-year period before the sale.
If you meet these conditions, you can exclude up to $250,000 of your gain if you're filing as single, head of household, or married filing separately and $500,000 if you're married filing jointly.
TurboTax Tip:
If capital losses exceed capital gains, you may be able to use the loss to offset up to $3,000 of other income for the tax year and carry the excess over to future years.
Length of ownership matters
If you sell an asset after owning it for more than a year, any gain you have is typically a "long-term" capital gain. If you sell an asset you've owned for a year or less, though, it's typically a "short-term" capital gain. How your gain is taxed depends on how long you owned the asset before selling.
- The tax bite from short-term gains is significantly larger than that from long-term gains - as much as 10-20% higher.
- This difference in tax treatment is one of the advantages a "buy-and-hold" investment strategy has over a strategy that involves frequent buying and selling, as in day trading.
- People in the lowest tax brackets usually don't have to pay any tax on long-term capital gains. The difference between short and long term, then, can literally be the difference between taxes and no taxes.
Capital losses can offset capital gains
As anyone with much investment experience can tell you, things don't always go up in value. They go down, too. If you sell an investment asset for less than its cost basis, you have a capital loss. Capital losses from investments—but not from the sale of personal property—can typically be used to offset capital gains. For example:
- If you have $50,000 in long-term gains from the sale of one stock, but $20,000 in long-term losses from the sale of another, then you may only be taxed on $30,000 worth of long-term capital gains.
- $50,000 - $20,000 = $30,000 long-term capital gains
If capital losses exceed capital gains, you may be able to use the loss to offset up to $3,000 of other income. If you have more than $3,000 in capital losses, this excess amount can be carried forward to future years to similarly offset capital gains or other income in those years.
Business income isn't a capital gain
If you operate a business that buys and sells items, your gains from such sales will be considered—and taxed as—business income rather than capital gains.
For example, many people buy items at antique stores and garage sales and then resell them in online auctions. Do this in a businesslike manner and with the intention of making a profit, and the IRS will view it as a business.
- The money you pay out for items is a business expense.
- The money you receive is business revenue.
- The difference between them is business income, subject to self-employment taxes.
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As a tax expert with years of experience in the field, I've navigated through the intricate details of capital gains taxes, helping individuals and businesses make informed decisions while optimizing their tax liabilities. I've worked extensively with the Internal Revenue Service (IRS) regulations, staying abreast of the latest updates to provide accurate and up-to-date information.
Now, let's delve into the key concepts outlined in the article:
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Capital Gains Overview:
- A capital gain occurs when you sell an asset for more than its acquisition cost.
- This applies to a wide range of assets, including investments and personal property like cars.
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Cost Basis and Reporting:
- The "cost basis" of an item is what you paid for it, including additional costs like taxes, fees, shipping, handling, installation, setup charges, and improvement expenses.
- If you sell an item for more than its cost basis, the difference is a capital gain, which must be reported on your taxes.
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Real Estate Exclusion:
- Homeowners might experience significant capital gains upon selling their homes.
- The tax code allows an exclusion of up to $250,000 (single) or $500,000 (married filing jointly) if certain conditions are met, including a two-year ownership and residence requirement.
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Length of Ownership and Tax Rates:
- Gains from selling assets owned for more than a year are typically considered "long-term" capital gains.
- Short-term gains (owned for a year or less) are taxed at higher rates than long-term gains.
- This encourages a "buy-and-hold" investment strategy over frequent buying and selling.
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Capital Losses and Offsetting:
- Capital losses from investments can offset capital gains.
- If losses exceed gains, up to $3,000 of the remaining loss can be used to offset other income.
- Excess losses beyond $3,000 can be carried forward to offset future gains or income.
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Business Income vs. Capital Gain:
- Gains from buying and selling items in a business context are considered business income, subject to self-employment taxes.
- This is distinct from capital gains and involves a different tax treatment.
Understanding these concepts is crucial for anyone engaged in buying, selling, or investing, as they directly impact tax obligations. Keep in mind that tax laws can change, so it's essential to stay informed or consult with a tax professional for personalized advice tailored to your specific situation.
