Understanding Capital Gains Tax

Whenever you sell such a capital item, the IRS taxes the gain on the item. This tax is called the capital gains tax.

The IRS levies a tax on the profit you realize when you sell a capital item. Capital items are items such as shares of stock, a house, or a coin or stamp collection. Whenever you sell such an item, the IRS taxes the gain on the item. This tax is called the capital gains tax.

Capital gains may be either long-term or short-term, depending on how long you have held the asset. If you sell an asset you have owned for one year or less, your gain is classified as short-term. A gain on an asset held over a year is characterized as a long-term gain. This is an important distinction, as long-term gains are taxed at a lower rate than short-term gains. Short-term gains are taxed at the same rate as your ordinary income. So if you are in the 28% tax bracket, you will pay 28% tax on your gain. Many long-term gains are taxed at a rate of 15%, but the rate can vary from 0 to 28%.

If your gain is long-term, the amount of tax you will pay depends on several factors: the type of asset and your federal tax rate. If you have sold stock and your federal tax rate is either 10% or 15%, you will pay a 5% capital gains tax. If you have sold stock and your federal tax rate is 25%, you will pay a 15% capital gains tax on the net profit.



If you have sold investment real estate that you have held for over a year, the calculations for your tax are more complicated. If you have sold an actual piece of property, you must first calculate the depreciation you have taken on the property over the years. This depreciation has reduced your basis in the property, which in turns leads to a larger net gain on the property. If you are in a federal tax bracket of 25% or higher, the amount of the gain up to the amount of depreciation taken over the life of the asset is taxed at the maximum rate of 25%. The rest of the gain is taxed at the long-term capital gains rate of 15%. If you are in the 10 or 15% tax bracket, the recaptured depreciation is taxed at your federal tax rate. The rest of the gain is taxed at the maximum rate of 15%.

If you own shares in a real estate investment trust (REIT) that you have held for over a year and the REIT sells some capital property, you will receive a capital distribution. The capital gains tax on this distribution will be at the maximum rate of 25% if you are in the federal tax bracket of 25% or above. If you are in a lower tax bracket, you will be taxed at your own tax rate.

If you sell collectibles such as stamps, coins, or baseball cards that you have owned over a year, the maximum rate of capital gains tax is 28%. If your federal tax rate is 15% or below, you will be taxed at that rate.

Some small business stock is taxed at the maximum rate of 28%, while some of this stock is not taxed at all. The rules for this are complicated, so consult a tax professional if you have shares of small stock that you have sold. But generally, the rules state that up to 50% of the gain on the sale of stock in a small corporation that was given to you and which you have held for more than five years is not taxable. The rest of the gain is taxable at a maximum rate of 28%.

If you sell a home that you have lived in for two of the last five years, the first $250,000 of the gain is not taxable if you are single. If you are married, the first $500,000 of the gain is excluded from taxation. If your gain is greater than those amounts, the remainder of the gain is taxed at a maximum rate of 15%.

If you have capital losses, you may use them to offset your capital gains. You must first net short-term losses against short-term gains, and long-term losses against long-term gains. If you do not have capital gains, you may still offset any other income you have, such as salary and interest income, with a short-term loss up to a loss of $3,000. If your loss is larger than $3,000, you must carry the remainder over to the next year. If the loss is carried over, it is considered a long-term loss. If you have no short-term gain and no long-term loss, you may net the short-term loss against a long-term gain up to $3,000. If you have a long-term loss and a short-term gain, you may net the long-term loss against the short-term gain. If the long-term loss exceeds the short-term gain, you may offset up to $3,000 of any other income against the long-term loss. If you have any long-term loss left over after that, you may carry it over to the next year.

© High Speed Ventures 2011