Capital Gains Explained

Once upon a time, the concept of capital gains was pretty much limited to businesses and wealthy taxpayers who had a lot of stuff (assets) they owned for investment purposes. Now, a lot of taxpayers have investments of one kind or another, so the idea of reporting capital gains or losses shouldn’t be so foreign to us.

So, let’s take a look at the basics of capital gains and losses.

The Beginning

Capital gains or losses start with capital assets – property, really – such as your home or car. Capital assets can also include investment property like stocks and bonds. In fact, the term capital asset can encompass most property you own and use for personal or investment purposes.

When you sell a capital asset, the sale usually results in a capital gain or capital loss.

What you paid for the asset is called the basis. So a capital gain or loss is the difference between your basis and the amount you get when you sell that asset.

Tax Consequences

The big rule here, is that you must include all capital gains in your income. A small twist in that rule was added this year, because some wealthy taxpayers may now be subject to the Net Investment Income Tax. That’s a 3.8 percent rate that applies to certain net investment income of individuals, estates, and trusts that have income above certain threshold amounts.

Capital losses on the sale of investment property can be deducted. Sale of personal-use property cannot be deducted.

It’s time that determines whether your gain or loss is long-term or short-term. If you held the property for more than one year, your gain or loss is considered long-term. If you held it for a year or less, the gain or loss is short-term.

When comparing gains and losses, the term can be a factor in how the result is classified. For instance, if your long-term gains outweigh your long-term losses, you’d have a “net long-term capital gain.” But if your long-term gains are greater than short-term losses, you’d have a “net capital gain.”

By the Numbers

The tax rates that apply to net capital gains will usually depend on your income. The rate may be as low as zero percent on some or all net capital gains for lower income taxpayers. In 2013, the maximum net capital gain tax rate was boosted from 15 to 20 percent. Some special types of net capital gains could be subject to tax rates as high as 25 or 28 percent.

When you run your numbers, if your capital losses are more than your capital gains, you can deduct the difference as a loss on your tax return. The loss is limited, though, to $3,000 per year. That limit drops to $1,500 if you are Married Filing Separately.

Got more than the $3,000 limit in losses?  You can carry over the remainder to next year’s tax return, and treat those losses as if they happened that year.

To report capital gains or losses on 1040.com, use Form 1099-B – Stock Transactions and Sale of Assets. You’ll also need to file a Schedule D – Capital Gain/Loss Carryovers with your return.