Almost all assets held for personal use or investment purposes including your home, jewelry, stocks and bonds are classified as capital assets and any gain on their sale is subjected to capital gains tax. Just as income taxes are required to be paid on the total taxable income, similarly taxes have to be paid on the total capital gains made by an individual or a corporation in a year.
The Long And Short Of It
Capital gains are classified as short term or long term based on the length of time the investor holds the asset prior to selling it. Capital gains are generally taxed at a rate lower than ordinary income and vary depending upon the length of time the investor has held the asset.
Short term capital gains which mean gains on sale of investments held for a year or less than a year are taxed at the tax payer’s ordinary applicable rate of tax.
Long term capital gains tax which means tax on sale of investments held by an investor for a period longer than a year is 15%. For the years 2008, 2009 and 2010, long term capital gains tax for those in the tax brackets of 10% and 15% is zero.
The reduced rate of 15% on long term capital gains was brought into force in 2003 prior to which the rate was 20%. Though this reduced rate was to end in 2008, this was extended to the end of 2010 following the signing of the Tax Reconciliation Act in 2006.
Capital gains and deductible capital losses are required to be reported in Form 1040, Schedule D.
How Is Capital Gain/Loss Calculated?
The difference between the selling price and the acquisition price is not the basis on which capital gains are calculated. Instead, the ‘cost’ of the asset is calculated, taking into account factors such as improvements or investments on the asset, fees paid, etc.
Deductions Allowed In The Calculation Of Capital Gains Tax
A married couple filing returns jointly can claim a deduction of up to $500,000 of capital gains on sale of a house in which they have lived in jointly for at least two of five years preceding the sale. The applicable deduction for an individual is $250,000.
Capital losses on sale of investments excluding sale of personal residences can be set off against capital gains, and net capital losses may also be set off against ordinary income up to a limit of $3,000 per year. Further, additional net capital losses may also be carried over into subsequent years and set off against either capital gains or in its absence, against ordinary income.