Capital gains is income, whether your gain comes from real estate or stocks. Capital gains is taxed at a lower rate than ordinary income -- such the income you get from an employer -- but in general you report capital gains as income on your 1040. Many people who sell their personal residence, however, aren't required to report the gains on their 1040 and it therefore isn't taxed as income.
Capital Gains Defined
What makes capital gains different from your wages or salary is the source. Anything you own or use -- your personal home, rental property, your car, furniture -- is a capital asset. When you sell it, your profit or loss is a capital gain or loss. With real estate, you essentially calculate the "profits" you've made on the transaction: you take the sales price and subtract the purchase price as well as certain other costs -- such as improvements you've made to the house -- to figure your gains.
Although your capital gains are generally treated as income, you may be able to keep certain gains off your 1040. When you sell your personal home, provided you've lived there at least two of the previous five years, you can exclude $250,000 in gain: you don't pay capital gains tax on the gains and it doesn't become part of your income -- you don't even need to mention it on your tax return at all. If you file a joint return, you may be able to exclude up to $500,000, if you meet the added requirements for couples.
Unfortunately, you cannot claim capital losses on the sale of your primary residence. If your real estate investments go south, on the other hand, the red ink can be written off -- to some extent -- against other income. You can deduct up to $3,000 in capital losses from your other income. If you're married but filing separately, it's only $1,500. Bigger losses are deductible but it takes longer. If, say, you sell a rental house at a $5,000 loss you deduct $3,000 this year and carry over $2,000 to take off next year.
Any capital gains you don't exclude appear on your tax return as income, although they are taxed at a lower rate than your wages or self-employment income. If you have a high income to start with, a big capital gain can cause problems. If you have a Roth, for example, your modified adjusted gross income limits how much you can contribute. If you're single and your capital gains push your MAGI above $127,000, as of 2013 you can't contribute to a Roth.
A Durham, NC resident, Fraser has written about law, starting a business, balancing your budget and fighting evictions, among other legal and financial topics.