If you’re thinking about making a profit from the sale of stocks, bonds, or real estate, whether you’re a seasoned investor or just starting out, you should familiarize yourself with the tax implications of your actions.
The gain made on the sale of an investment, rather than the whole amount received, is subject to taxation. Therefore, it is essential to maintain thorough records beginning with the asset’s acquisition and ending with its sale. The amount you owe depends on a few variables, such as how long you owned the item and how high your marginal tax rate is.
Learn the ins and outs of capital gains and losses taxation here.
What Exactly Are Capital Gains and Losses?
You need to know certain simple terms to completely grasp the tax implications of capital gains and losses. Some terms we’ll be using here and it would be helpful if you knew their meanings:
- Investment Piece of Equipment. Stocks, bonds, real estate, and other valuable possessions are examples of capital assets. Almost everything you own, including your house, car, and other items, is considered a capital asset by the Internal
- Revenue Service. Anything that is used in the daily operations of a firm, such as inventories, is not considered a capital asset.
- Possibility of accumulating capital. In finance, a capital gain is the amount of money gained through the sale of an asset classified as capital, less the amount paid to acquire the asset. When the value of a capital item you possess, such a share of stock, rises while you hold onto it, you don’t have to pay any additional taxes on that gain. However, if the stock is sold at a higher price than what you originally paid for it, plus any transaction costs, you would owe taxes on the profit.
- Loss of Capital. When an investment is sold for less than it was originally purchased for, the seller incurs a capital loss.
- Base of operations. The amount you spent for a capital item, including any fees or taxes, is known as the cost basis.
The proper terminology for describing your investments has been established; now we can examine the Internal Revenue Service’s treatment of them.
How Do Capital Gains Get Taxed?
Capital gains taxes are calculated by taking into account the amount of money gained from the sale, the length of time the item was held, and the kind of the asset sold. When evaluating your investment returns, keep in mind the following:
Short-Term vs. Long-Term Holding Period
In order to determine the amount of tax to be paid on a capital gain or loss, two holding periods must be considered:
- Short-Term. Gains or losses on investments held for less than a year are considered short-term.
- Long-Term. Capital assets held for more than a year are subject to long-term profits and losses (365 days).
The rates at which you pay tax on your capital gains vary depending on whether or not they were earned over a lengthy period of time, or a short period of time. You’ll need the following records to figure out the asset’s cost basis and establish whether your gain will be taxed at the short-term or long-term rate:
- The precise date you acquired the asset.
- The purchase amount, including all applicable taxes and fees (you must also track additional investments made to increase the value of the asset, such as improvements made to real estate or dividends reinvested)
- The precise date of the sale.
- The sales price you got for the asset plus any associated fees and other expenses.
You can calculate the precise amount you need to disclose as a capital gain or loss and the tax rate that applies after you have all the necessary paperwork.
Rates of Capital Gains Tax
Any gains from a short-term investment are taxed at the same rate as “ordinary” income, which includes things like salary and commission. On the other hand, long-term capital gains are subject to a different taxation system.
Those percentages were based on your regular income tax brackets prior to the Tax Cuts and Jobs Act of 2017 (TCJA). In the years when the top marginal tax rate was 15%, long-term capital gains were taxed at 0%. Your capital gains tax rate was 15% if they were in the 25%-35% tax band. If your earnings were high enough to put you in the top tax bracket (currently 39.6%), then you paid that rate instead of the lower one (20%).
Long-term capital gains are still taxed at 0%, 15%, and 20%, but unlike before, they are no longer dependent on the taxpayer’s personal income level. Long-term capital gains are subject to their own tax rates between 2018 and 2025.
The tax treatment of various forms of capital investment is quite variable. Gains from the sale of a property or collectibles like art or antiques are subject to unique tax regulations from the Internal Revenue Service.
Capital Gains on the Sale of Your Home
A capital gain includes the profit made from the sale of one’s principal house. Thankfully, the tax legislation provides a few exemptions that will allow you to keep a sizable portion of your earnings.
- For the first $250,000 in gain, no taxes are due. You can’t miss out on this one. The first $250,000 in profit on the sale of a primary residence, or $500,000 if filing jointly, is exempt from capital gains taxation. This exemption is only available if the seller has lived in the property as their principal residence for two of the previous five years prior to sale and has not utilized this exclusion on another home in the preceding two years. For further information and for consideration of any applicable exceptions, please refer to Publication 523.
- Basis is boosted by closing expenses and capital expenditures. Many of the legal, title, and recording fees and commissions associated with the sale of your house are already factored into your cost base. The price tag for any major or extensive renovations to your house is included as well (but not repairs). If you keep track of these costs, you might be able to reduce your taxed gain.
Collectibles Capital Gains
Earnings from the sale of collections including paintings, stamps, coins, and antiques might be taxed in different ways than gains from other investments.
Gains from the sale of collectibles held for less than a year are subject to the same ordinary income tax rates as gains from the sale of stocks or other capital assets. However, the capital gains tax rate is now 28% on any profit made from the sale of collectibles held for more than a year.
What Effect Do Capital Losses Have on Taxes?
Capital losses can be used to reduce the size of capital gains made from the sale of other assets. If your capital losses are more than your capital gains, you can deduct up to $3,000 from your taxable income. However, if you are married but filing separately, you can only deduct up to $1,500.
Let’s pretend you realized $5,000 in capital gains on the sale of Stock A. You also lost $7,000 when you sold Stock B. Stock A gain can be reduced by $5,000 in long-term losses, and another $2,000 in capital losses can be used to reduce regular income like salary.
Carryover of Capital Losses
In the preceding example, what if your loss on Stock B was $9,000 instead of $7,000? You could apply $5,000 toward offsetting the gain from selling Stock A, $3,000 toward offsetting other income, and you’d still have $1,000 in capital loss remaining. Although you won’t be able to apply that extra loss this year, it will still be there next year. You will be able to use your capital loss carryover in a subsequent tax year.
Remember that the rules for writing off investment losses are stringent. You can only incur a capital loss if the asset was purchased with the intention of becoming an investment. To that end, you cannot deduct the loss you incur from the sale of a personal residence, motor vehicle, furnishings, or collectibles.
Keep an eye out for the Wash Sale Rule.
Investors selling failing equities in order to realize capital losses and claim a tax deduction create a flurry of activity in the last weeks of the year. Although this tactic can help you save money on taxes, you should be sure you actually want to sell the stock before you do so, as repurchasing it too soon can result in the loss of your capital loss deduction.
The purpose of this regulation, known as the “wash sale rule,” is to discourage traders from liquidating their holdings at the end of the year in order to take advantage of capital losses and then reinvesting those funds in the same security. If you sell shares at a loss and then purchase another “substantially similar” stock or investment within 30 days before or after the sale, the loss you incurred on the sale is not tax deductible under “wash sale” regulations. Check out IRS Publication 550 for a more in-depth analysis of the wash sale regulation.
Investment success requires either luck or a keen understanding of the market, but taking advantage of favorable tax treatment upon selling valued assets requires just careful strategy. Working with an experienced financial adviser and tax specialist from H&R Block can help you minimize your tax liability if you have a sizable stock, bond, or real estate portfolio.