Capital Gains Laws: An Overview

The government imposes a capital gains tax whenever an investor sells an asset, such as a house or business. A capital gain is the difference between what you pay to acquire an asset and what you ultimately sell it for. Assets can be tangible, like gold, property, or stocks, or even intangible such as copyrights or patents. The capital gains tax applies solely to profits from the sale of assets possessed for over a year. The capital gains tax is owed for the tax year during which the investment is sold and is only due after a property has been sold. It may be wise to utilize a capital gains calculator in order to properly prepare for any tax responsibilities. The capital gains tax varies from 0% to 20% depending on the filer’s income, and the income brackets are adjusted annually. Before selling an investment property, make sure you understand how much tax you’ll owe on the sold asset. 

Short vs. Long-Term

If you own the asset for less than a year, the profit is usually treated as if it were salary or wages for taxes. These gains are considered earned or ordinary income for tax purposes and are taxed at a higher amount than assets held for longer than a year. 

A different rule applies to long-term capital gains. Any assets held for more than a year and sold at a profit are subject to a rate schedule based on the investor’s taxable income for that same year. Rates are adjusted annually for inflation. 

Collectibles

Some categories of assets have different capital gains requirements than the standard. Gains on collectibles, such as coins, art, gold, etc., are taxed at a special 28% rate, no matter the filer’s annual income. This means that no matter if you are in a lower or high tax bracket, your gains on collectibles will be levied at the higher tax rate. 

Selling a Principal Residence

A different rate applies to real estate capital gains if you sell a principal residence, i.e., one in which the owner lives. $250K of an individual’s capital gains on the sale of a residence are excluded from taxable income, with up to $500K for those married filing jointly. This special rule applies so long as the seller has owned and lived in the home for over two years. It is important to note that capital losses from the sale of personal property are not deductible from net gains. 

Investment Property

Investors can use the natural deterioration of the property as it ages to deduct against your total tax liability. The depreciation deduction reduces the amount you’re considered to have paid for the property in the first place. This can affect your bottom line later by increasing your taxable capital gain when you sell the property. If you sell the property, the gap between its value after deductions and its sale price will be greater. 

Net Investment Income Tax

For those filers with a higher income, you may be subject to the net investment income tax, which imposes an additional 3.8% taxation on your investment income. This levy is based on whether your modified adjusted gross income or MAGI exceeds certain maximums. 

Capital Losses

Investments are inherently risky, and anyone with investment experience knows that an investment does not always appreciate in value. If you sell an investment property for less than its cost, you have a capital loss. Capital losses from investments can usually be applied to offset capital gains. Note, however, that you cannot calculate capital losses from the sale of personal property.  

If your capital losses exceed capital gains, you may be able to apply the loss to offset up to $3,000 of other income. If your net capital loss exceeds the annual $3K limit, the excess can be carried over to future years. You may use the Capital Loss Carryover Worksheet or Form 1040 from the IRS to calculate the amount you can carry forward. 

Capital gains calculator

Although there is a plethora of tax software that automatically makes the tax computations for you, you can use this capital gains calculator to receive a rough estimate of what you may pay on a potential or actualized sale. This tool is a good indicator of what you can expect to pay, though you should speak with a tax attorney to ensure your calculations are accurate. 

How Do I Report Capital Gains or Losses?

To report most capital gains, use Form 8949, Sales, and Other Dispositions of Capital Assets. You can find current instructions and updated revisions to reconcile your investment income and expenses here. 

The process changes a bit if you are using a tax broker to report capital gains. If you use a broker, they will complete Form 1099-B, and you won’t need to fill out Form 8949. Speak with a professional to guarantee you are completing the correct form. 

What Happens If I Don’t Pay Capital Gains?

No matter the origin of the capital gains, the IRS requires you to report it. If your capital gains are not included in your tax filing, there is a significant chance that the IRS will discover through some other reporting means. The IRS will likely impose fines and penalties for failing to report capital gains. The IRS can even seek criminal prosecution if they can prove that the act was intentional, fraudulent, or purposeful to evade paying taxes. Consult with your tax advisor to ensure you have included the appropriate forms to report all necessary transactions on your taxes. 

Do I Need a Tax Attorney if I Didn’t Pay Capital Gains?

Dealing with the IRS alone can be a stressful experience. While you are not required to have representation when facing the IRS, it is highly recommended. If the IRS asks for additional documentation regarding your capital gains or an investigation has been initiated, it is in your best interest to hire an experienced tax attorney. A tax attorney will guide you through the reporting process and help negotiate with the IRS to reduce potential fines and late fees. A tax attorney is worth the investment if only to deal with the IRS directly. Visit Expertise’s legal directory to find a tax attorney in your area. 

How Can I Reduce My Capital Gains?

Many folks who invest are looking to make a profit. No matter what kind of asset, you will likely owe capital gains taxes on the net profit. However, there are a multitude of legal ways to minimize your capital gains taxes: 

• Track your investment losses since these losses can be deducted from your net profits. The maximum amount per year that you can claim is $3,000. If your losses are greater than the $3K loss, the excess loss can be applied to later years. 

• Hold onto the property for longer than a year to avoid the asset’s profits being taxed as regular income. 

• Keep a detailed record of any qualifying expenses that you incur in making or maintaining the asset. These expenses increase the cost of the investment and therefore reduce its taxable profit. 

• Take advantage of tax-advantaged accounts, such as a 401(K) or IRA. You can use these accounts to buy and sell assets without the capital gains tax liability. 

• Research potential exclusions. There are rules that allow investors to exclude portions of the gains from the sale of the asset, so you should understand the specific criteria to meet these exclusion requirements.