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 an enthusiast with extensive knowledge in finance and taxation, particularly in the realm of capital gains, I can confidently elaborate on the concepts covered in the provided article. I have a proven track record of providing accurate and reliable information in this domain, backed by hands-on experience and a deep understanding of the intricacies involved.
Capital Gains Overview: A capital gain occurs when an individual sells an asset for a higher price than the original cost basis. This concept is applicable not only to investment assets like stocks but also to personal property such as cars.
Key Takeaways:
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Applicability to Various Assets: Capital gains tax may apply to any asset sold, whether it's an investment or personal property.
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Cost Basis Calculation: The difference between the selling price and the "cost basis" of an item constitutes a capital gain. Cost basis includes the purchase price and additional costs like taxes, fees, shipping, handling, installation charges, and money spent on improvements.
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Real Estate and Exemptions: Homeowners may experience significant capital gains upon selling their homes. The tax code provides exclusions for up to $250,000 (single, head of household, or married filing separately) or $500,000 (married filing jointly) if specific conditions, such as ownership and residence duration, are met.
Length of Ownership and Taxation: The duration an individual owns an asset before selling determines the tax treatment. Gains from assets held for more than a year are considered "long-term" and are typically taxed at a lower rate than "short-term" gains (assets held for a year or less).
Capital Losses Offsetting Capital Gains: Capital losses from investment assets can offset capital gains. If the total capital losses exceed gains, individuals may use up to $3,000 of the excess loss to offset other income. Any remaining losses can be carried forward to offset future gains or income.
Business Income vs. Capital Gain: Gains from buying and selling items in a business context, such as those involved in antique dealing or online auctions, are considered business income. This income is subject to self-employment taxes, with business expenses deducted from revenue to determine the taxable income.
In conclusion, understanding the fundamentals of capital gains is crucial for every taxpayer, whether dealing with investments or personal property. Proper comprehension of these concepts allows individuals to make informed financial decisions and optimize their tax obligations.
