Long-term capital gains are earned on investments or real estate you hold on to for a year or more. They're taxed by the Internal Revenue Service at a different, generally lower, rate than your ordinary income. Most taxpayers pay a long-term capital gains tax of 15 percent.
Understanding Capital Gains and Loss
If you own items or investments like a house, stock or art and sell it, you treat that money differently from ordinary income such as your salary, bank interest or dividends you receive. Such items and investments are called capital assets. The amount you earn on them is called a capital gain. If you sell the item for less than you paid for it, that is a capital loss.
Generally, IRS capital gains rules say that you compute the price you paid for the capital asset, plus any commissions or fees you paid to acquire it, and call that its cost basis. Then, you take the price you sold it for, minus any commissions or fees you paid on the sale. The difference is your capital gain or loss.
If you had the asset for less than a year, that's a short-term capital gain or loss. Otherwise, it's a long-term capital gain or loss.
If you had securities that became worthless, such as if a company became bankrupt and its stock or bonds are worth nothing, treat them for tax purposes as if you sold them for $0 on the last day of the tax year they became worthless.
Your Capital Gains Tax Rate
If you have short-term capital gains, they're generally taxed at your ordinary income tax rate, the same as income from work or bank interest.
If you have long-term capital gains, they're taxed at a generally lower long-term capital gains tax rate. For most assets, this is either 0 percent, 15 percent or 20 percent, depending on your total income. Consult IRS tax tables, a tax preparer or tax prep software to find your long-term capital gains rate. Certain types of assets such as collectibles and some small business stock can be taxed at a higher rate of 28 percent.
Report your capital gains on Form 8949. You may also owe state or local tax on capital gains. Consult your state's tax authority for details.
Capital Loss and Tax
If you have capital losses, they can be used to reduce your total tax. Generally, long-term losses offset long-term gains, and short-term losses offset short-term gains, with you paying tax on the net gain or loss of each type.
If you have more short-term losses than gains or more long-term losses than gains, the losses can offset the other type of gain. If you have more total losses than gains, you can deduct up to $3,000 in capital losses from your ordinary income. If you have more than $3,000 to deduct, you can use what is called a capital loss carryover to save these losses for future tax years.
Each tax year you apply the same procedure to new and carried over losses, offsetting first capital gains and then up to $3,000 in ordinary income and carrying the rest forward to future tax returns.
Some investors will choose to pair sales of stocks or other investments that have gone up in value with ones that have lost value to offset their capital gains with capital losses in the same year. Whether you think it is worth it to do so will likely depend on your tax rates and your belief about where each of your investments is headed.
The Wash Sale Rule
One exception to ordinary capital gains and loss rules involves what is called loss sales. These involve selling a security such as a stock share or bond and buying the same or a substantially identical security within 30 days before or after the sale.
If investors could sell a stock at a loss and repurchase the stock, they could claim capital losses on any money-losing stock when convenient for at most only a few dollars in trading commissions. To prevent this, the IRS says that if you make such a series of transactions, you can't claim the capital loss immediately. Instead, you add the loss to the cost basis of the newly purchased stock or other security.
When you ultimately sell the securities for good, that will let you effectively offset your gain or claim the loss.
Exemptions for Home Sales
If you sell your primary residence for a capital gain, you can exempt up to $250,000 in gain from tax or up to $500,000 if you're a married couple filing jointly.
To be eligible to do this, you must have owned the house and had it as your primary residence for at least two of the five years before the sale. The ownership periods and use periods don't have to be the same periods. There are more generous rules if you're stationed away from your home with the military, foreign service or intelligence agencies. With some exceptions, you can generally only claim the exemption on one home sale every two years.
You must report the sale on Form 8949 and Form 1040 if you receive a 1099-S form for the home sale or if any of the gain is not excludable.
Inheriting Capital Assets
If you inherit capital assets when someone passes away, special rules apply.
Ordinarily, the cost basis of a capital asset is determined from what you paid for it. If you inherit an asset, it is instead the value of the asset on the date the original owner died. In some cases, the estate executor or administrator can elect to use the value of estate assets six months after the date of death instead, but the concept works the same way.
If an asset has gone up in value, this can save the heirs substantial money in capital gains tax should they sell the asset later on. If it's gone down in value, it can effectively lead to higher capital gains tax than if the original owner sold it before death. These can be considerations in deciding how to dispose of assets in estate planning.
Donating Capital Assets
If you have securities or other assets that have gone up in value, you may consider donating them to a worthy nonprofit.
For assets subject to long-term capital gains or losses, you can usually deduct the full fair market value of the donation, similar to donating cash. These donation deductions are limited to 30 percent of your adjusted gross income, compared to 60 percent from cash donations, and you must itemize your deductions to claim any charitable donations. You can carry over excess charitable deductions for up to five years.
For short-term capital gains assets, you can donate the fair market value minus what your capital gain would be if it sold. It may be worth holding on to some assets until you realize long-term gains before donating them unless you think they'll depreciate in that time.
With assets that have lost value, it can make more sense to sell the assets, claim the capital loss and donate the proceeds for a tax deduction.
- IRS:Topic Number 409 - Capital Gains and Losses
- IRS: Topic Number 701 - Sale of Your Home
- IRS: Publication 550
- Bankrate: Capital Losses Can Help Cut Your Tax Bill
- IRS: Wash-Sale Rule
- Investopedia: Step Up in Basis
- Olsen Thielen: Should You Elect the Alternate Valuation Date for Estate Tax?
- CNBC: Donating Stock Is a Triple Play
- Charles Schwab: Charitable Donations: The Basics of Giving