If you sold something – a house, a car, some stock or even gold or silver coins – you may have a capital gain or loss.
When we think of taxable income, most of us primarily think of our earned income, such as wages or self-employment pay. We don’t always include the car we sold on Craigslist or the stocks we cashed in as part of that group.
From the perspective of the IRS, however, anytime you sell an item and collect money, it’s potentially a taxable event. And, if you live in a state with state income tax, your state may see it that way, too.
Fortunately, you seldom have to pay tax on the entire amount of proceeds. Typically, you’re only responsible to pay capital gain tax on the gain.
A gain is the dollar amount you made on the sale. This is calculated by taking the amount you received minus the amount you originally paid for the asset.
For example, if you bought one ounce of gold years ago at $300, and you sell it at $1,200, you have a gain of $900 ($1,200 – $300 = $900).
What’s a tax basis?
The amount you originally paid for an asset is generally your tax basis.
However, in some cases it’s more complicated.
If you take depreciation deductions for the asset, your tax basis is reduced by the deductions. A lower tax basis means a higher taxable gain when you sell.
On the flip side, if you make improvements to the asset, the amount you spend increases your tax basis.
For example, if you have a rental house and add a deck to it, the amount you spend on the deck increases your tax basis.
Your tax basis adjusted for depreciation deductions, improvements and any other adjustments is called your adjusted basis.
This is the amount you use to determine if you have a capital gain or loss when you sell an asset.
What’s a capital asset?
Most personal items you own, such as a car, investments or real estate, are capital assets.
If you own a business, all business assets are not considered capital assets. This includes any inventory, equipment and supplies used for business purposes.
Additionally, if you’re creative, any songs you’ve written or copyrights to your own creations are not considered capital assets either.
How do capital gains benefit me?
Typically, capital gains are taxed at a more favorable rate than your standard salary or wages, which is why this form of income can have a greater impact on your pocketbook. However, that isn’t true in every case as not all capital gains are the same. Your tax rate varies dramatically based on the classification of the capital gain.
Capital gains are broken down into two categories: long-term and short-term.
A short term capital gain refers to any profit made from the sale of an asset you owned for one year or less. This type of gain does not benefit from any special tax rate as it is taxed the same as your ordinary income.
A long-term capital gain is the exact opposite. If you hold onto your asset for more than one year, you can benefit from a reduced tax rate on your gain. This rule was created in an effort to encourage long-term investment in the economy.
If I have long-term capital gains, how much tax will I have to pay?
The difference in income tax rates is substantial.
In fact, if you are in a low- to moderate-income tax bracket (use this calculator to find out which tax bracket you are in), your capital gains tax rate may be zero.
That’s right – you may have a gain and not have to pay any tax on it at all. This rule mainly applies to people who fall into the 10 percent or 15 percent income tax brackets. For tax year 2016, that includes anyone whose taxable income after deductions (and including any capital gains) is less than $37,650 ($75,300 if you file jointly).
If your total taxable income is in the 25 percent to 35 percent tax brackets, your capital gains rate is 15 percent. If your income borders the bracket lines, you may have some capital gains taxed at 0 percent and some taxed at 15 percent.
Additionally, if you sell your personal residence, you may not have to pay tax on up to $250,000 gain from your home. This rule goes into effect if you owned and lived in the house for at least two of the last five years or if you meet certain exceptions.
In the case that you’re married, you may be able to exclude up to $500,000 gain from the sale of the home as long as you meet the requirements.
Where can I see my capital gains tax on my tax return?
TaxAct calculates your capital gains on Schedule D, Capital Gains and Losses. You can also see your total capital gains tax on Page 2 of your Form 1040, U.S. Individual Income Tax Return.
If you have a stock that’s gone up in value, do you usually wait until you’ve owned it more than one year before you sell it, to take advantage of capital gains tax rates?