To understand capital gains, it is first essential to understand what a capital asset is. Anything that you own and make use of for personal or investment purposes is a capital asset. It can be your home, furniture, stocks, precious metals, vehicles, fine art, and bonds in your personal account. When you sell a capital asset, the difference between the amount you received in exchange for the capital asset and the amount you spent when you purchased it, is called capital gain or capital loss.
How Capital Gain or Loss is Determined
When the price at which you sold the capital asset is more than the price at which you bought it, you have a capital gain. Capital gains are considered taxable income. Income generated from capital assets such as rent, dividend, interest and royalties is also taxable. If the price at which you sold the capital asset is less than the price at which you bought it, you have a capital loss. If a taxpayer's capital losses exceed their capital gains, the taxpayer can usually claim those losses as a tax deduction up to $3,000 per year.
Capital assets such as property and precious metals usually provide capital gains, as their prices almost always rise with time. Capital assets that sustain wear and tear with time such as a vehicle, furnishings and electronic appliances will usually be capital losses.
Short-Term Capital Gains and Long-Term Capital Gains
If you hold a capital asset for more than a year, it is considered long-term. If you hold a capital asset for a year or less, it is considered short-term. The tax rate is different on long-term and short-term capital gains.
The tax rate for long-term capital gains can be zero percent, 15% or 20%. The tax rate depends on many factors, including your marginal tax bracket. Low-income individuals may not be charged any taxes on capital gains.
Short-term capital gains are taxed at the same rate as the taxpayer's ordinary income, depending on their tax bracket. The top tax bracket rate is 39.6%.
The top tax rate on long term capital gains has risen to 20% this year. High income earners will also need to consider the new additional 3.8% surtax. The tax rates on long term capital gains are usually lower than the taxes charged on other types of income. When paying tax on capital gains, various factors influence the amount of taxes you will be required to pay. These factors include the length of time you hold a capital asset, your tax bracket, and the type of asset you are selling.
The tax rate on short term capital gains has remained the same as in 2013 and is unlikely to be changed in the near future. If you buy and sell capital assets in a year or within a year, the taxes assessed will be the same as what you pay on your income. Holding onto capital assets for longer than a year can potentially help you to save in taxes.
Tax Filing Requirements
You need to include all capital gains on your tax return, but you can only deduct capital losses on investment property and not on property that you are using for personal use. To report capital gains and losses, you will need to file Form 1040. You must then report all the gains or losses on Schedule D, Capital Gains and Losses, and transfer the information to line 13 of Form 1040.
You can carry over your net capital losses from one year to the next, if your net capital loss is higher than the maximum limit for capital loss deductions for a year