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As the IRS points out, just about everything you own qualifies as a capital asset. Whether it’s your house, furniture, car, stocks, bonds, coin or stamp collections, jams and jewelry, they are all capital assets. While capital gains and losses are generally associated with stocks and funds due to their inherent price volatility, a capital gain or loss can occur on any capital asset that is sold for a price higher or lower than the purchase price that was paid for it.
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Before even considering taxation, you need to classify your gains and losses as either ordinary or capital gains or losses. You then need to classify your capital gains and losses as either short term or long term.
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If you have long-term gains and losses, you must identify your 28% rate gains and losses. If you have a net capital gain, you must also identify any unrecaptured section 1250 gain. The correct classification and identification helps you figure the limit on capital losses and the correct tax on capital gains.
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- Gains and losses from the sale or exchange of capital assets receive separate treatment from ordinary gains and losses. Capital gains are taxed before income, at a significantly lower rate than ordinary gains. Capital losses, on the other hand, are only useful to offset capital gains and a small amount of personal income. A capital asset is any property owned by you except the following:
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- Stock in trade or other property included in inventory or held mainly for sale to customers.
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- Accounts or notes receivable for services rendered in the ordinary course of your trade or business.
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- Depreciable property used in your trade or business, even if it is fully depreciated.
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- Real estate used in your trade or business.
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- A copyright; a literary, musical, or artistic composition; a letter or memorandum; or similar property that is created by your personal efforts; prepared or produced for you or received under circumstances that entitle you to the basis of the person who created the property or for whom the property was prepared or produced.
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- A U.S. Government publication, including the Congressional Record, that you received from the government for less than the normal sales price, or that you received under circumstances that entitle you to the basis of someone who received the publication for less than the normal sales price.
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- Certain commodities derivative financial instruments held by a dealer and connected to the dealer's activities as a dealer.
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- Certain hedging transactions entered into in the normal course of your trade or business.
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- Supplies regularly used in your trade or business.
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| Capital gains and losses are classified as long-term or short-term. If you hold investment property more than 1 year, any capital gain or loss is a long-term capital gain or loss. |
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If you hold the property 1 year or less, any capital gain or loss is a short-term capital gain or loss.
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| To determine how long you held the investment property, begin counting on the date after the day you acquired the property. The day you disposed of the property is part of your holding period. |
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| For securities traded on an established securities market, your holding period begins the day after the trade date you bought the securities, and ends on the trade date you sold them. (Do not confuse the trade date with the settlement date, which is the date by which the stock must be delivered and payment must be made.) |
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| You must report most sales and other capital transactions and calculate capital gain or loss on Form 8949, Sales and Other Dispositions of Capital Assets, then summarize capital gains and deductible capital losses on Form 1040, Schedule D, Capital Gains and Losses. |
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| If you have a net capital gain, a lower tax rate may apply to the gain than the tax rate that applies to your ordinary income. The term "net capital gain" means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss for the year. The term "net long-term capital gain" means long-term capital gains reduced by long-term capital losses including any unused long-term capital loss carried over from previous years. |
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| The tax rate on most net capital gain is no higher than 15% for most taxpayers. Some or all net capital gain may be taxed at 0% if you're in the 10% or 15% ordinary income tax brackets. |
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| However, a 20% tax rate on net capital gain applies to the extent that your taxable income exceeds the thresholds set for the 39.6% ordinary tax rate. |
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| For tax year 2016 the 39.6 tax rate thresholds are: $418,401 for single, $466,950 for married filing jointly or qualifying widow(er), $441,000 for head of household, and $233,475 for married filing separately. |
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| For tax year 2017 the 39.6 tax rate thresholds are: $415,050 for single, $470,701 for married filing jointly or qualifying widow(er), $444,551 for head of household, and $235,351 for married filing separately. |
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There are a few other exceptions where capital gains may be taxed at rates greater than 15%:
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- The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
- Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
- The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.
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Section 1250 is a section of the Internal Revenue Service Code that states that a gain from selling real property that has been depreciated should be taxed as ordinary income, to the extent that the accumulated depreciation exceeds the depreciation calculated using the straight-line method. Section 1250 bases the amount of tax due on the type of property, such as residential or nonresidential property, and on how many months the property was owned. Personal property, either tangible or intangible, and land do not fall under the scope of this tax regulation. Section 1250 is mainly applicable when a company depreciates its real estate using the accelerated depreciation method, which results in larger deductions in the early life of a real asset, in comparison to the straight- line method. Section 1250 says that if a real property sells for a purchase price that produces a taxable gain, and that property is depreciated using the accelerated depreciation method, the difference between the actual depreciation and the straight-line depreciation is taxed as ordinary income.
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| Net short-term capital gains are subject to taxation as ordinary income at graduated tax rates. |
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If you have your own business, your business assets (equipment, furniture, tools) are taxed as ordinary gains and are reported on Form 4797, Sales of Business Property.
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If your capital losses exceed your capital gains, the amount of the excess loss that you can claim on line 13 of Form 1040 to lower your income is the lesser of $3,000, ($1,500 if married filing separately) or your total net loss shown on line 16 of the Form 1040, Schedule D.
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If your net capital loss is more than this limit, you can carry the loss forward to later years.
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| A 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts. |
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| For individuals, the NIIT is 3.8 percent on the lesser of: |
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- the net investment income, or
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- the excess of modified adjusted gross income over the following threshold amounts:
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$250,000 for married filing jointly or qualifying widow(er) with dependent child; |
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$125,000 for married filing separately; |
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$200,000 in all other cases. |
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| You should know that these threshold amounts are not indexed for inflation. |
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| In general, net investment income for purpose of this tax includes, but isn't limited to: |
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- interest, dividends, certain annuities, royalties, and rents (unless derived in a trade or business in which the NIIT doesn't apply),
- income derived in a trade or business which is a passive activity or trading in financial instruments or commodities, and
- net gains from the disposition of property (to the extent taken into account in computing taxable income), other than property held in a trade or business to which NIIT doesn't apply.
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| The NIIT doesn't apply to certain types of income that taxpayers can exclude for regular income tax purposes such as tax-exempt state or municipal bond interest, Veterans Administration benefits, or gain from the sale of a principal residence on that portion that's excluded for income tax purposes. |
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| Modified adjusted gross income (MAGI), for purposes of the NIIT, is generally defined as adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned income exclusion (but also adjusted for certain deductions related to the foreign earned income). For individual taxpayers who haven't excluded any foreign earned income, their MAGI is generally the same as their regular AGI. |
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You can compute the tax on Form 8960, Net Investment Income Tax— Individuals, Estates, and Trusts.
If you expect to be subject to the NIIT tax next year you should adjust your income tax withholding or estimated payments to account for the tax increase in order to avoid underpayment penalties.
As you certainly assumed by now, professional expertise is indispensable in navigating through the complexity of the IRS rules and regulations regarding capital gain and losses, as well as other tax issues that may apply to your particular situation. |
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