Capital gains are the proceeds you receive from the sale of a capital asset. The definition of a capital asset varies, but includes things such as collectibles, stocks, bonds, dividends and real estate. The IRS taxes gains on capital assets differently depending on the type of asset that was sold; the main determining factor is how long the asset was held. How you are taxed also depends on your filing status, as well as the amount of income you earned for the year.
Although short term capital gains are taxed at your ordinary income rate, long term capital gains receive more favorable treatment, with tax levels at either 0, 15 or 20 percent. There are exceptions for depreciated commercial real estate and other special cases like collectibles.
Understanding Capital Gains Tax
For tax purposes, the IRS classifies any capital gains on the sale of capital assets as either long-term or short-term gains. The difference between the two is determined by how long you held onto the asset before selling it. Short-term capital gains are gains you realized from the sale of a capital asset you’ve held onto for less than a year before selling it.
In this case, the IRS will tax these capital gains at your regular income tax rate. Depending upon your tax bracket, you could find yourself paying a higher rate on part of your income up to the 2017 maximum tax rate of 39.6 percent or 2018 maximum of 37 percent. Also, if your income exceeds a certain threshold, you will have to pay an additional 3.8 percent Medicare surtax on both long and short-term capital gains as part of the Affordable Care Act. You can generally use a capital gains calculator program to compute the tax or follow the IRS instructions to apply the relevant tax rates.
On the other hand, long-term capital gains are proceeds from the sale of a capital asset that you held onto for more than a year, and the IRS taxes these gains much more favorably. For the 2017 and 2018 tax years, taxes on long-term capital gains are 0, 15, or 20 percent, depending on your total income.
If you make little enough money altogether, you could be taxed at 0 percent and escape capital gains taxes all together. It is worth noting that not all long-term capital gains are taxed equally. Depending upon the type of capital asset, you could be taxed at different rates on the profit.
Capital Gains that Are Taxed Differently
Certain long-term capital gains are taxed at different rates. Proceeds from the sale of real-estate held for longer than a year, and that you depreciated on your taxes, can be subject to a 25 percent capital gains tax applied to the portion of the gain up to the amount previously deducted for depreciation. This tax, known as depreciation recapture, generally applies to investment property, not people's homes. Compute this tax with IRS Form 4797.
The long-term capital gains you receive from the sale of collectible items such as antiques, card collections, stamps and coins, are taxed at a maximum rate of 28 percent, depending on your overall income.
Recent Tax Law Changes for 2018
The definition of short and long-term gains has remained the same under the new tax law, as has the 3.8 percent Medicare surtax. Capital gains tax brackets for the different rates have changed only slightly, though they're now different income ranges than ordinary income tax brackets.
You will generally pay less on short term gains, taxed at the ordinary income rate, since these rates have gone down for most taxpayers.
Tax Law for 2017
Most of the tax law changes that went into effect December 20, 2017 are not retroactive, and therefore do not impact 2017 taxes that you will file in 2018. For purposes of capital gains taxes, nothing has changed that will have bearing on your 2017 tax return.
Long term capital gains tax rates for 2017 are 0, 15 percent or 20 percent, and short term gains rates are your ordinary income rates, which are generally lower than they will be for the 2018 tax year.
- IRS: Capital Gains and Losses – 10 Helpful Facts to Know
- IRS: Topic No. 409 Capital Gains and Losses
- CnnMoney: 34 things you need to know about the incoming tax law
- TheMotleyFool: Your Guide to Capital Gains Taxes in 2018
- Investopedia: Depreciation Recapture
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts And More
- Investopedia: How Are Collectibles Taxed?