Capital gains are profits you make from selling capital assets, which includes almost everything you own -- from your house to stocks to paintings, according to the Internal Revenue Service. Under certain circumstances, as of the 2014 tax year, capital gains are taxed at lower rates than your ordinary income. However, like all tax code, the capital gains rates are subject to change.
Long-Term Capital Gains
Long-term capital gains refer to profits from selling capital assets you've owned for more than one year and are lower than the ordinary income tax rates. As of 2014, these lower rates range from zero percent if you would have paid up to a 15 percent ordinary income tax rate, 15 percent if the ordinary rate would be above 15 percent but below 39.6 percent, and 20 percent for long-term capital gains that would be taxed at the top rate of 39.6 percent.
Short-Term Capital Gains
Short-term capital gains, the profits from selling capital assets you owned for one year or less, are taxed at the same rates as your ordinary income. You don't receive any tax break. For example, say you sell a stock you've owned for six months for a $4,000 profit. That $4,000 is taxed at your marginal tax rate, which, as of 2014, ranges from 10 percent to 39.6 percent.
Exceptions to Long-Term Gains Rates
Certain types of long-term capital gains may be taxed at higher rates than the standard long-term gain rate. The maximum rates on gains from the sale of collectibles and certain qualified small business stock under Section 1202 is 28 percent. Collectibles include art, antiques, metals, coins, gems and alcoholic beverages. Unrecaptured gain on real estate, such as if you've depreciated a rental that you sell for a profit, is taxed at a maximum of 25 percent.
Net Investment Income Tax
If you have enough income during the year, you'll owe an extra 3.8 percent tax, called the Net Investment Income Tax, on both your long-term and short-term capital gains. As of the 2014 tax year, you'll owe the tax if your modified adjusted gross income exceeds $250,000 if you file a joint return, $200,000 if you're single or $125,000 if you're married but file separate returns. For example, if the Net Investment Income Tax applies and your long-term gains would normally be taxed at 15 percent, you'll pay a total of 18.8 percent.
Primary Residence Exception
The primary residence exclusion allows you to avoid paying any taxes on the first $250,000 ($500,000 if you're married) of capital gains from selling your primary residence. To qualify, you must have owned the home for at least two of the previous five years and used it as your primary home for at least two of those five years. The primary residence exclusion also applies to the net investment income tax. For example, if you sell your home for a $200,000 profit but meet the criteria, you won't pay any income taxes on those capital gains.
- Legal Information Institute: 26 USC 1
- IRS: Questions and Answers on the Net Investment Income Tax
- IRS: Topic 409 -- Capital Gains and Losses
- Legal Information Institute: 26 USC 408
- IRS: Topic 701 - Sale of Your Home
- Internal Revenue Service. "Publication 544 (2018): Sales and Other Dispositions of Assets," Page 20.
- Internal Revenue Service. "Topic No. 409 Capital Gains and Losses." Accessed Feb. 13, 2020.
- Internal Revenue Service. "IRS provides tax inflation adustments for tax year 2020."
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."