The Capital Gains Tax


Nobody can deny that they don’t have any capital assets. If some people think they really don’t then they might not know what it is actually. Almost whatever you own and use for your personal purposed or pleasure or investment is a capital asset according to the definition given by IRS. Now here comes the capital gain, when you sell a capital asset like home, the difference between the amount you sell it and the original amount you paid for it is a capital gain or capital loss. The original amount that you have invested to buy is also called ‘basis’. If you sell the asset for more than the basis then you have made a capital gain and you have a capital loss if you sell the asset for less than its basis.

While it is mandatory to report all capital gains you have made, you can only deduct capital losses on investment property only not your personal property. Capital gains and losses are classified as long term and short term depending on how long you held it. Typically, if you held the asset for less than a year before you sell it is called a short term capital gain or loss. If you held it for more than a year then it is no longer considered short term, in that case it is called long term capital gain or loss. Use Schedule D, Capital Gains and Losses, and then transfer it to line 13 of Form 1040 to report Capital Gains and Losses.

There are many misconceptions about capital; most people think that capital is the money invested in the stocks or in the business only but on the contrary it is not just the financial asset. It is also physical investment such as the building, the factory, the computers, the fax machines, the printers and what not. Capital can also refer to a technological improvement or an idea that leads to the creation of a new business or a product.

Let us look into one of the scenarios. If you have a gain from sale or exchange from the sale of your main home, you may be able to exclude all or part of the gain from your income. The exclusion may be allowed each time you sell or exchange your main home but generally no more frequent than once every 2 years. You may not be able to deduct the capital loss from your taxes. The required two years of ownership would not have to be continuous in the 5 year period ending on the date of sale. You can meet the ownership and the use tests during two different years. However, both tests must be met before the 5 year period ending on the date of sale or exchange. If you do not pass both tests you may be allowed to exclude the gain made from selling or exchanging of your home only if:

 - You had to sell or exchange your home due to a change in place of employment or health or unforeseen circumstances.

All other circumstances would incur you a capital gain tax. So, talking about tax how much tax you should pay and what are the rates, are the questions that pop up in your mind. Capital gain tax rates are computed by the type of investment asset and the holding period. Your Capital Gains may also be subject to state capital gain tax in addition to the federal tax. Most states do not have separate capital gain tax rates instead they tax your capital gains as the ordinary income which is subjected to the state income tax.

The following are the capital gain tax rates:

Capital Gains Tax Rates

Type of Capital Asset
Holding Period
Tax Rate
Short-term capital gains (STCG) One year or less Ordinary income tax rates up to 35%
Long-term capital gains (LTCG) More than one year 5% for taxpayers in the 10% and 15% tax brackets
15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets
Collectibles One year or less STCG tax rates up to 35%
Collectibles More than one year 28%
Small Business Stock Gains (Section 1202) More than five years 28% on the gain not excluded
Real Estate Main Home One year or less STCG
More than one year LTCG taxed at 5% or 15% after any exclusion amount


Calculate Your Capital Gains

You calculate profits or losses on each capital investment you made. Here's the formula for calculating your profit or loss on a single investment:

Selling price - Selling fees & commissions - Minus Buying fees & commissions - Minus Purchase price = Profit (or Loss if negative)

But Form 1040 Schedule D doesn’t provide any place to put information about fees and commissions. So what you can do is to add all commissions, fees, and the purchase price together into one figure called "cost basis” which is calculated as:

Purchase price + Purchase commissions and fees + Selling commissions and fees = Cost Basis

This gives us a very simple formula:

Selling Price - Cost Basis = Capital Gain or Loss

One important thing to note is that individual retirement accounts like IRA, Roth IRA and 401(k) are not reported as capital gains they are tax deferred accounts. Meaning there are no capital gains on Tax Deferred Investments. With so many aspects of Capital Gain Tax being covered in this article you may have a clear idea of what a capital gain tax is. It will help you in making smarter investment decisions in future.