You realize capital gains when you make money from the sale of certain types of property. The Internal Revenue Service (IRS) taxes capital gains at rates that are generally lower than the tax rate for ordinary income. If you incur capital losses, you can sometimes deduct them from capital gains to reduce the amount of capital gains tax you owe. You report capital gains on IRS Form 8949 and Schedule D.
Applies to the Sale of Capital Assets
Most of your assets are likely classified as capital assets by the IRS. Capital assets typically include your home, your car, your personal property, and your investment assets such as stocks and bonds. Business inventory and accounts receivable are not classified as capital assets. Neither are creative works and certain intellectual property rights. When you sell non-capital assets for a profit, you are taxed at ordinary income tax rates.
Capital Gains Are Reduced by Cost Basis
The IRS may measure your profit differently than your accountant does. The IRS measure of capital gains is the sale price minus the asset's "adjusted basis." Although the asset's "cost basis" is the amount you paid for it, the basis can be adjusted based on several factors. If you buy a house and add improvements before you sell it, the value of the improvements must be added to its cost to determine its adjusted basis, thereby reducing your capital gain. If the house depreciates in value by the time you sell it, the amount by which it depreciates must be subtracted from its basis, thereby increasing your capital gain.
Not All Capital Gains Are Taxable
Certain types of capital gains are non-taxable. For example, if you realize a capital gain by selling your primary residence, you are exempt from capital gains tax on the first $250,000 (or $500,000 for a married couple filing jointly) if you lived in the home for two of the five years preceding the sale. You can also delay paying capital gains tax by promptly reinvesting the proceeds of the sale of certain types of property into the purchase of "like-kind" property.
Short-Term and Long-Term Capital Gains
You realize a short-term capital gain when you own an asset for less than a year before selling it. If you own an asset for a year or more before selling it, you realize a long-term capital gain. On your tax return, you must divide all of your capital gain or loss transactions into short-term and long-term transactions, and you must calculate a single sum for each category. A net short-term capital gain is taxed at ordinary income tax rates. A net long-term capital gain, however, is taxed at capital gains tax rates. You can deduct any net short-term capital losses from your net long-term capital gains.
A Tax Lawyer Can Help
The law surrounding capital gains tax is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a tax lawyer