Understanding Capital Gains and Losses
What's a capital asset, and how much tax do I have to pay when I sell?
What's a Capital Gain?
A capital gain is what the tax law calls the profit when you sell a capital asset, which is property such as stocks, bonds, mutual fund shares or property. The profit is your gain over the basis paid. The basis is typically defined as the original price plus any related transaction costs.
What's the Difference Between a Short-Term Gain and a Long-Term Gain?
A very big difference. The law divides investment profits into different classes determined by the calendar. Short-term gains come from the sale of property owned one year or less; long-term gains come from the sale of property held more than one year.
What Is the Holding Period?
That's the period you hold the property before you sell it. When figuring the holding period, the day you buy property does not count, but the day you sell it does. So, if you bought a stock on April 16, 2013 your holding period began on April 17. Thus, April 16, 2014, would mark the end of the first year. If you sold on that day, you would have a short-term gain or loss. A sale on April 17 would produce long-term results, though, since you would have held the asset for more than one year.
How Much Do I Have to Pay?
The tax rate you pay depends on whether your gain is short-term or long-term.
Short-term profits are taxed at your maximum tax rate, just like your salary, up to 39.6%.
Long-term gains are treated much better. Long-term gains are taxed at 15% for taxpayers in four tax brackets (25%, 28%, 33%, 35%). If you're in the highest bracket bracket (39.6%), then your long-term gains are taxed at 20%. Low-bracket taxpayers (10% and 15%) pay no capital gains tax at all.
There are exceptions, of course. Long-term gains on collectibles such as stamps, antiques and coins are taxed at 28% for the five upper tax brackets; tax payers in the lower brackets are taxed at their normal rates.
Gains on real estate attributable to depreciation are taxed at 25%, unless you're in the 10% or 15% bracket. (This is Uncle Sam's way of taking back tax deductions from depreciating a property is actually sold at a profit.)
Capital gains may also be subject to the Net Investment Income Tax, set up to fund the Affordable Care Act. If your income is above $200,000 ($250,000 if filing jointly), there’s an additional 3.8% levy.
What is a Capital Loss?
A capital loss is a loss on the sale of a capital asset such as a stock, bond, mutual fund or real estate. As with capital gains, capital losses are divided by the calendar into short- and long-term losses.
Can I Deduct my Capital Losses?
Losses on your investments are first used to offset capital gains of the same type. So, short-term losses are first deducted against short-term gains and long-term losses are deducted against long-term gains.
QUIZ: Test Your Investing IQ
Net losses of either type can then be deducted against the other kind of gain. So, for example, if you have $2,000 of short-term loss and only $1,000 of short-term gain, the extra $1,000 of loss can be deducted against long-term gain. If short- and long-term losses exceed all of your capital gains for the year, up to $3,000 of the excess loss can be deducted against other kinds of income, including your salary, for example, and interest income.