Capital Gains Tax and Capital Loss Deductions

The IRS taxes income from capital gains and income from dividends differently than regular income.

What Are Capital Gains?

Basically, a capital gain is a profit made from selling an asset.

When you sell an asset, if the difference between the price you paid (or your basis price) and the price for which you sold it is positive, the profit is called a capital gain. If the difference is negative, it's called a capital loss. Capital gains are taxed by the IRS at a different tax rate than regular income. Capital losses, on the other hand, can be deducted from your income.

Qualified dividends are also considered capital gains.

What Is an Asset?

An asset is anything you own for business, for personal use, or for investment purposes. An asset can be anything from stocks, to collectibles, to real estate.

What Are Long-Term and Short-Term Capital Gains?

Capital gains can be classified as long-term and short-term. If an asset is held for more than one year, then any profit from the sale of  the asset is considered a long-term capital gain. If an asset is held for a year or less before it is sold, then any capital gain is considered short-term, and is taxed differently than a long-term capital gain.

To determine the amount of time which the asset was held, count the number of days from the date you purchased the asset through (including) the date you sold the asset.

Qualified dividends are always considered long-term capital gains.

What Are the Capital Gains Tax Rates?

Short-term capital gains are taxed as ordinary income. You will pay whatever your effective tax rate is.

Long-term capital gains are generally taxed at a rate of 15%, but there are some exceptions. The most important exception affects anyone with a marginal tax rate of 10% or 15%:

  • If your tax bracket is 10% or 15%, then your capital gains tax rate is 0% (this provision was made permanent by the American Tax Relief Act of 2012).
  • Capital gains from selling collectibles are taxed at 28% (or at your marginal tax rate, if it is lower than 28%).
  • Capital gains from selling Section 1202 qualified small business stock are taxed at 28% (or at your marginal tax rate, if it is lower than 28%).
  • Capital gains from selling Section 1250 real property that is required to be recaptured in excess of straight line depreciation are taxed at 25% (or at your marginal tax rate, if it is lower than 25%).

ATTENTION:

As it stands, starting with the 2013 tax year, capital gains tax rates are subject to go up to 20%. If nothing changes, this will affect the tax return that you will file in 2014.

Do I Have to Pay Capital Gains Tax on the Sale of My Home?

In most cases, you do not have to pay tax on any profit you made from selling your main home. You can generally exclude this profit from your income if you owned your home and lived in it for at least 2 years out of the 5-year period leading up to the sale.

You cannot exclude the income if you already excluded income from another home sale in the 2 years before the sale of this home.

Capital Loss Deductions: Can I Deduct a Capital Loss?

If your long-term capital losses on investment property are more than your capital gains for the year, then you can deduct your capital losses, but they are not a regular itemized deduction. The maximum amount you can deduct is $3,000 ($1,500 if you are Married Filing Separately) or your total net loss if it's less than $3,000. If your net loss is greater than the maximum allowed amount, you can carry the excess amount over to future tax years.

You can deduct capital losses on investment property only, not on property that was owned for personal use.

How Do I Report Capital Gains and Capital Losses on My Tax Return?

All capital gains (other than profit from the sale of your main home) are required to be reported on your tax return. If you receive capital gains income from a corporation or investment company, you should receive a Form 1099-B or a Form 1099-DIV stating the amount of income you received. Undistributed capital gains are reported to you on Form 2439 and are taxable. Even if you do not receive one of these forms, you must still report your capital gains income.

To report capital gains to the IRS, you must file Form 1040, Schedule D and Form 8949.

Capital losses can be deducted from your taxable income using Form 1040, Schedule D. Capital loss carryovers  are reported using the Capital Gains Carryover Worksheet.

When you prepare your return on efile.com, the online tax software will select the appropriate forms for you and make sure that they are filled out correctly.

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