As you probably already know, the IRS recently received a significant infusion of funds from the Inflation Reduction Act. The IRS is hoping to increase the audit rate from its current sub-one percent performance, focusing on higher-income tax returns. Examining higher income returns makes sense, as does investigating returns with income from sources that aren’t easily verified. For example, the IRS reports that for ordinary wages and salary income, compliance with reporting and paying income tax is nearly perfect. In contrast, for income from harder-to-verify sources like small businesses, noncompliance may be as high as 55 percent.
Capital gains are simple for the IRS to validate in most cases, so taxpayers are wise to report and pay what’s due. As the IRS has noted, capital assets include almost everything you own:
A capital gain or loss is the result of selling a capital asset for more or less than you paid for it (your basis). The basis is key to reporting a gain or loss. In some cases, it is simply the price (if you buy a stock, for example, and sell it, the purchase price is the basis, and the gain or loss is the difference between the basis and the sales price). But the basis may be adjusted, particularly when the asset is real estate.
Adjustments to the basis may include property improvements and the cost of acquisition. Adjustments can also include depreciation and receipt of payments from other sources that offset your investment.
First, keep in mind that there are short and long-term capital gains, and the rate at which each is taxed differs. A short-term gain results from the sale of any asset you have owned for less than a year. The tax rate on short term gains is the same as you pay for ordinary income—which may be as much as 37 percent. In contrast, long-term capital gains rates apply to assets you sell after holding them for at least a year, and the maximum tax levy on the gain is 20 percent.
Whether you are reporting short or long term gains (or losses), you will use Form 8949 and Schedule D with your 1040 filing. While the IRS won’t tax you on sales that result in losses, report them anyway so you can use them to offset current or future gains. Form 8949 requires the type of asset sold, the acquisition and disposition dates, and both the basis and sale price.
Remember, if you prefer to defer the payment of capital gains, consider executing a 1031 exchange to replace the property you sell with a property of equal or greater value. This tool allows you to reinvest the entire proceeds from selling the real estate and can be performed repeatedly, with advance planning.
You won’t need form 8949 if the gain you are reporting comes from a stock sale, as long as your broker has provided you with a 1099-B detailing the transaction. The IRS gets a copy of this form, so they will know if you fail to report the gain.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.