Almost everything you own and use for personal or investment purposes can be considered a capital asset. This includes items like your home, personal belongings like furniture, and investments such as stocks and bonds. When you sell a capital asset, the difference between its adjusted basis and the amount you receive from the sale determines whether you have a capital gain or a capital loss. Understanding What Is A Capital Gains Tax is crucial for financial planning.
Understanding Capital Gains and Losses
A capital gain occurs when you sell an asset for more than its adjusted basis. Conversely, a capital loss occurs when you sell an asset for less than its adjusted basis. The basis of an asset is typically its original cost. However, if you received the asset as a gift or inheritance, the basis might be determined differently. Consult Publication 551, Basis of Assets for detailed information. It’s important to note that losses from the sale of personal-use property, such as your personal car, are generally not tax deductible.
Short-Term vs. Long-Term Capital Gains
Capital gains and losses are classified as either short-term or long-term. This classification is vital because it affects the tax rate applied. Generally, if you hold an asset for more than one year before selling it, any resulting capital gain or loss is considered long-term. If you hold the asset for one year or less, the capital gain or loss is short-term.
Determining the holding period involves counting from the day after you acquired the asset up to and including the day you disposed of it. There are exceptions to these rules, such as property acquired as a gift or from a deceased person. For specific situations, refer to Publication 544, Sales and Other Dispositions of Assets, Publication 550, Investment Income and Expenses, and Publication 541, Partnerships.
Capital Gains Tax Rates: What You Need to Know
One of the key aspects of what is a capital gains tax is understanding the applicable rates. If you have a net capital gain, it may be taxed at a lower rate than your ordinary income.
For example, for taxable years beginning in 2024, the tax rate on most net capital gain is no higher than 15% for most individuals, but can be 0% if your taxable income is less than or equal to:
- $47,025 for single and married filing separately;
- $94,050 for married filing jointly and qualifying surviving spouse; and
- $63,000 for head of household.
A capital gains rate of 15% applies if your taxable income is:
- more than $47,025 but less than or equal to $518,900 for single;
- more than $47,025 but less than or equal to $291,850 for married filing separately;
- more than $94,050 but less than or equal to $583,750 for married filing jointly and qualifying surviving spouse; and
- more than $63,000 but less than or equal to $551,350 for head of household.
However, a capital gains rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate.
Keep in mind these important exceptions:
- 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 (like 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.
Important Note: Net short-term capital gains are taxed as ordinary income at your regular income tax rates.
Deducting and Carrying Over Capital Losses
If your capital losses exceed your capital gains, you can deduct a limited amount of the excess loss to reduce your income. The deductible amount is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss. You can claim this loss on line 7 of your Form 1040, Form 1040-SR or Form 1040-NR. If your net capital loss exceeds this limit, you can carry the unused loss forward to future tax years. Publication 550 and the Instructions for Schedule D (Form 1040) PDF provide detailed instructions.
Reporting Capital Gains and Losses
Understanding what is a capital gains tax also means knowing where to report it. Most sales and other capital transactions are reported on Form 8949, Sales and Other Dispositions of Capital Assets. Capital gains and deductible capital losses are summarized on Schedule D (Form 1040).
Estimated Tax Payments and Net Investment Income Tax
If you anticipate owing capital gains tax, you may need to make estimated tax payments throughout the year. Refer to Publication 505, Tax Withholding and Estimated Tax, Estimated taxes and Am I required to make estimated tax payments? for more information.
Individuals with substantial investment income may also be subject to the net investment income tax (NIIT). See Topic no. 559 for more details.
Where to Find Additional Information
For further details on what is a capital gains tax and how it applies to your specific situation, consult Publication 550 and Publication 544. If you sold your main home, also see Topic no. 701, Topic no. 703 and Publication 523, Selling Your Home. Properly understanding capital gains taxes can help you make informed financial decisions.
