If you profit from the sale of an asset, the profit is called a capital gain, which is subject to taxes. All assets are not taxed the same, and you can hang onto more of your profit by including all allowable deductions for each asset. Assets can be almost anything you own, including real estate, jewelry and stocks. Capital-gains taxes are driven by factors such as your tax bracket, the type of property you sell and how long you own the property before you sell it. To calculate what you’ll pay in taxes on your capital gains, you’ll start at the beginning – with your asset’s basis.
What is an Asset's Basis?
The amount you paid to purchase your asset is the asset’s basis. If you received the asset as a gift, its basis depends on its fair-market value. The purchase cost of your asset can include amounts other than its actual sales price, such as sales taxes, freight charges for shipping and handling, some settlement fees, transfer fees and title insurance. Costs you cannot include in your asset’s basis include those associated with obtaining a loan, such as loan origination fees, appraisals and mortgage insurance premiums. IRS Publication 551, “Basis of Assets,” lists costs you can and cannot include to determine your asset’s basis.
How to Calculate an Asset's Adjusted Basis
Before you calculate the taxes you’ll pay on capital gains, it’s important to calculate the adjusted basis of each asset. An asset’s adjusted basis includes any costs that increase or decrease the asset’s value. If the adjusted basis is more than its original sales price, the asset is a capital gain. If the adjusted basis is less than its original sales price, the asset is a capital loss. When you sell an asset, your tax liability will be lower if the asset is considered a capital loss.
Is an Asset Long-Term or Short-Term?
If you own an asset for less than a year before you dispose of it, it is a short-term asset. If you own an asset for more than a year, it’s a long-term asset. The exact formula for determining the length of ownership of your asset is to count the days starting from the day after you acquired it through the day you disposed of it. You’ll pay higher taxes on short-term assets than on long-term assets. Typically, short-term assets are taxed at the same rate as your income, but long-term assets give you a greater tax break.
How to Calculate An Asset's Net Capital Gain
You may have multiple assets that result in more than one capital gain in a tax year. The IRS allows you to subtract your capital losses from your capital gains, which means that you can reduce the overall capital-gains amount on which you’re taxed. The total of your long-term capital gains minus your long-term capital losses equal your net long-term capital gain. If you subtract your net short-term capital loss from your net long-term capital gain, the result is your net capital gain, which is the amount that is taxed.
Calculating Your Capital Gains Taxes
Now that you’ve calculated your asset’s adjusted basis, determined whether it’s a short-term or long-term asset and calculated your net capital gain, it’s time to pull out the tax forms and compute your taxes. The good news is that the maximum tax you’ll pay on a net capital gain is 20 percent. Even better news is that most taxpayers will either pay zero or 15 percent.
This tax rate depends largely on your income and tax bracket. Gather all your income paperwork, such as W-2 ("Wage and Tax Statement") and 1099-B ("Proceeds from Broker and Barter Exchange Transactions") forms; and add IRS Form 8949, “Sales and Other Dispositions of Capital Assets,” and Schedule D, “Capital Gains and Losses,” to your work desk to pull everything together.
Reporting Capital Gains on Your Tax Return
Form 8949 includes line-item instructions and worksheets to help you calculate your capital gain or loss for the tax year. Based on these calculations, you’ll know the amount of capital-gains income, if any, to add to your other income sources when you file your tax return. When you complete 8949, you’ll transfer certain line-item amounts as directed to Schedule D, which you include with your tax return.
Types of Assets Subject to Higher Taxable Amounts
Although the tax on most capital gains is lower than 15 percent, the IRS lists three notable exceptions that are subject to higher tax rates:
- If you sell Section 1202-qualified small-business stock, the taxable portion of the gain carries a tax rate of 28 percent.
- If you sell collectibles, such as art or coins, the net capital gains carry a maximum tax rate of 28 percent.
- If you sell Section 1250 real property, the portion of any unrecaptured gain carries a maximum tax rate of 25 percent.
If your capital gains are less than your capital losses, you can deduct some of your net capital loss from your net capital gain. The IRS places a $3,000 maximum limit on the amount of net capital loss that you can claim to reduce your tax liability ($1,500 if you are married and filing separately). After you complete your tax worksheets, if the amount of net capital loss that you enter on line 13 of Form 1040 exceeds this limit, you won’t lose all of this benefit. You’ll complete the "Capital Loss Carryover Worksheet" that is included in Publication 550, “Investment Income and Expenses,” which instructs you how to compute the amount that you can carry over to the next tax year.
Business Income vs. the Sale of a Business
If you own a business that buys and re-sells items, your profit from the business is not a capital gain. It’s considered business income, and it is taxed accordingly. The money used to purchase items for the business is a business expense, and the money you receive from the sale of the items is business revenue.
If you sell your business, that's a different matter. You'll typically figure a gain or loss for each asset. For example, the sale of real estate or depreciable property that you owned for longer than one year is usually a gain or loss from a 1231 transaction, but the sale of your business inventory is considered ordinary income or loss. Section 1231 of the IRS Code discusses 1231 transactions, which include some livestock and natural resources as well as real property.
IRS tax laws are not static. Because they are subject to change from year to year, you'll want to make sure that you use only the current forms, which you can download from the IRS website (IRS.gov). These forms reflect any new tax legislation. The information in this article is current for filing 2017 tax returns.
- IRS: Publication 551 -- Basis of Assets
- IRS: Topic 409 -- Capital Gains and Losses
- IRS: Capital Gains and Losses -- 10 Helpful Facts to Know
- IRS: Form 1099-B -- Proceeds from Broker and Barter Exchange Transactions
- IRS: Form 8949 -- Sales and Other Dispositions of Assets
- IRS: Schedule D -- Capital Gains and Losses
- IRS: Instructions for Form 8949
- IRS: Publication 550 -- Investment Income and Expenses (Including Capital Gains and Losses)
- IRS: Sale of a Business
- IRS: Publication 544 -- Chapter 3, Ordinary or Capital Gain or Loss for Business Property