When a taxpayer sells an asset for more than its basis, it’s generally regarded as taxable income. This can be any asset - from a real estate investment property to your car or even your TV. These are considered capital gains, and taxpayers are responsible for accurately reporting this information to the IRS.
Income from capital gains are taxed differently than ordinary income. Your ordinary income tax percentage (earnings from employment, self-employment, interest, dividends, or royalties) is dependent on your tax bracket, while the tax percentage on income from capital gains is dependent on how long the seller held that asset and is realized when it’s sold at a price higher than its basis. However, income from an investment property, such as rent, is taxed as ordinary income.
Not every capital asset qualifies as being taxable, including business inventory and depreciable business property. If a property is being used for personal use, such as your primary residence, you may exclude some or all gain as long as:
If these conditions are met, $250,000 can be excluded if single and $500,000 if married and filing jointly.
The length of ownership is important because it affects how much tax you end up paying on that asset. Long-term capital gains result from assets that are held for more than one year before being disposed of. The tax rate for long-term capital gains is 0%, 15%, or 20%, dependent on your taxable income and filing status. Long-term capital gain tax rates are generally lower than short-term tax rates.
Short-term capital gains result from assets that are held for less than a year before being disposed of. Short-term capital gains are subject to taxation as regular income to one of the seven federal tax brackets with rates ranging from 10% to 37%.
There are several strategies to minimize or defer capital gains tax:
Your income tax liability should be part of your investment strategy, and it’s up to the taxpayer to report any realized gain for tax purposes. A tax professional can assist you in estimating your tax liability on capital gains.