Understanding Capital Gains and Losses

Chris Bibey
by Chris Bibey

Do you know anything about capital gains and losses? If not, you should learn about them as soon as possible because they can have an impact on your tax return as well as your overall financial situation.

A capital asset is basically anything that you own/use for personal or investment purposes. This can include stocks, bonds, home furnishings, and the home itself. When you sell a capital asset, the difference between your “basis” (usually the amount you paid for it) and what you sell it for is called a capital gain or loss.

If you sell an asset for more than your basis, you have a capital gain. Conversely, if you sell an asset for less than your basis, you have a capital loss.

Here are several facts that you should know about capital gains and losses, as well as capital gains tax:

• Capital gains are either short-term or long-term, depending on how long you hold the asset before selling it. If you hold it for more than one year, it is considered a long-term capital gain or loss. If you hold it for a year or less, it is a short-term capital gain or loss.

• If your long-term capital gains for the year are greater than your capital losses (including short-term and long-term losses), then you have a “net capital gain.”

• Net capital gains are subject to tax. However, the rates for capital gains tax are generally lower than the tax rates for other types of income (e.g., individual or corporate income). The amount of your capital gains tax depends on your tax bracket and whether the asset is short-term or long-term.

• Short-term capital gains are taxed at your regular income tax rate. The maximum capital gains tax rate for long-term capital gains is 15% for most taxpayers (for 2009). Particular types of long-term capital gains are taxed at 25% to 28%. Some lower-income individuals may even qualify for a 0% capital gains tax rate on their net capital gains.

• Net capital losses can be claimed for a tax deduction. If you have more capital losses than gains, you can deduct the difference on your tax return to reduce your taxable income. There is a $3,000 annual deductible limit for taxpayers who are married filing jointly and a $1,500 annual limit if you file separately.

• Capital losses can be deducted on investment property, but not property that is for personal use.

• Net capital losses may be carried over. If your total net capital loss is more than the limit described above, you may “carry over” the excess amount to the following year (as if it was acquired in that next year). This is a benefit that many taxpayers are unaware of.

• All capital gains and deductible capital losses must be reported to the IRS using Tax Form 1040, Schedule D (Capital Gains and Losses). The information reported on Schedule D must also be recorded on Line 13 of Tax Form 1040.

There are tax advantages to capital gains and losses. For example, you do not pay capital gains tax on capital gains until your asset is sold. And while a capital loss is not necessarily a good thing, it can be deducted on your tax return.

The information above should help you understand the basic features of capital gains and losses, and how they affect can affect your capital gains tax situation.