We’re guessing most of you have heard the terms Capital Gain, Capital Loss, and Capital Gains Tax. But do you know what these terms mean? Probably not. That’s what we’re going to address in this post!
Before we get into the capital gains and losses, let us first understand what a Capital Asset is.
Everything you own and use either for your personal use or for investment purposes is a capital asset. For instance, your home, your furniture, your car, the stocks/bonds that you hold – all of these are capital assets.
While an asset’s basis generally refers to its original cost, adjusted basis refers to the increase or decrease in the value of that asset due to capital enhancements or depreciation deductions respectively. Now, capital gain or loss pertains to the difference between the adjusted basis in the asset and the amount generated from the sale of a particular capital asset. So, if you sell a capital asset for an amount that exceeds your adjusted basis, you make a capital gain. Contrarily, you incur a capital loss when you sell an asset for an amount that’s less than your adjusted basis.
Short-Term and Long-Term Capital Gains/Losses
Capital gains and losses are classified into two categories: short-term and long-term. If you are in possession of a capital asset for one year or less before you sell it, your capital gain/loss is considered to be a short-term capital gain or loss. On the other hand, if you hold onto a capital asset for over a year and more, the profit or loss you make when you dispose of it is considered to be a long-term capital gain/loss.
Reporting Your Capital Gains/Losses
You must report your sales and other capital transactions on Form 8949 (Sales and Other Dispositions of Capital Assets). You can calculate your capital gains and losses in the same form. However, you have to summarize your capital gains or losses on Form 1040, Schedule D (Capital Gains and Losses).
How Are Capital Gains Taxed?
Usually, if you make a short-term capital gain, you will be taxed at your ordinary income tax rate (25%). However, if you make a long-term capital gain, you may be taxed at a lower rate. Also, if you make a net capital gain, you will be subject to a lower tax rate. Net capital gain refers to the amount by which your aggregate long-term capital gain for a particular year exceeds your aggregate short-term capital loss for that year. Although most net capital gains are taxed at 15% or less for taxpayers under ordinary income brackets, the tax rate on the net capital gains may rise up to 20% if a taxpayer’s income exceeds the thresholds taxed under the 39.6% tax rate – $418,400 for single individuals; $470,700 for married couples filing jointly or qualifying widow(er); $444,550 for head of household, and $235,350 for married filing separately. There are also other instances where capital gains may be taxed at a rate higher than 15%:
- Net capital gain made from selling valuable collectible like as art or coins are taxed at a maximum rate of 28%.
- The taxable portion of a capital gain from selling a Section 1202 qualified small business stock is also taxed at a maximum rate of 28%.
- Any unrecaptured Section 1250 gain made by selling a Section 1250 property is taxed at a maximum rate of 25%.
Quarterly Estimated Tax Payments
Usually, you have to declare your capital sales while filing your income tax return, but if a substantial part of your income is not subject to tax withholding, for instance, gains made from selling a capital asset, the IRS may demand that you make quarterly estimated tax payments. As for the tax year 2018, you are required to make quarterly payments under the following two circumstances:
- If your withholding and refundable credits make up less than 90% of your total tax paid (or 100% of the tax) in the previous year.
- If you owe more than $1,000 in taxes.
Can Capital Losses Be Deducted?
Yes, you can deduct your capital losses, but there are certain limitations of course. When you consider deducting your losses, first they must be used as a collateral of any capital gains you’ve made. In other words, your short-term capital losses are first deducted against your short-term capital gains and your long-term capital losses are deducted against the long-term capital gains. Also, your net losses (both short-term and long-term) can be deducted against your net long-term capital gain (if you have it). Thus, if you have a net capital loss for any particular year, you are allowed to deduct up to $3,000 against any other kind of income such as salary or interest income. However, this limit gets reduced to $1,500 if you claim deduction under the married filing separate status.
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