What are Capital Gains/Losses?
Capital gains and losses arise from the sale of an asset, which can be equipment, land, stock and other property with a monetary value. A taxpayer will have a gain when they sell the asset for more than they purchased it for, and a loss when they sell it for less. For example, if you bought land for $50,000 and later sold it for $75,000, then it would equate to a capital gain of $25,000. If you later sold it for only $40,000, it would be a capital loss of $10,000.
Short Term vs Long Term:
The two different types of capital gains and losses are short term and long term, and the differentiation is very important for taxes. For a capital gain/loss to be considered short term, the asset must be held for one year or less before the date of sale. For long term capital gains and losses, the asset must be held for over one year before the date of sale. Short term capital gains and losses are taxed at the ordinary income tax rate while long term capital gains and losses are taxed at the capital gain rates which are decided by your taxable income. The table below shows the capital gain rates, so you can see which rate you fall under:
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Capital Gain Rates |
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|
Single |
Married Filing Jointly |
Head of Household |
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|
Capital Gain Rate |
Taxable Income |
Capital Gain Rate |
Taxable Income |
Capital Gain Rate |
Taxable Income |
|
0% |
$0 – $38,600 |
0% |
$0 – $77,200 |
0% |
$0 – $51,700 |
|
15% |
$38,601-$425,800 |
15% |
$77,201-$479,000 |
15% |
$51,701-$452,400 |
|
20% |
$425,801 or more |
20% |
$479,001 or more |
20% |
$452,401 or more |
Netting Capital Gains and Losses:
In order to input the correct amount into the capital gains and losses section of the tax return, you net them together to come up with either one or two separate numbers, depending on your scenario. The first step in netting capital gains is losses is netting them by long term or short term. For example, if you have long term capital gains of $4,000 and long-term capital losses of $2,000, it would come out to be a net of $2,000 long term capital gains. The same process will be used for short term capital gains and losses. If both short term and long term are gains, then you must disclose them separately on the tax return since they are taxed at different rates. If there is a short-term gain of $10,000 and a long-term loss of $6,000 then you would net them together which results in a net short term gain of $4,000. One thing to note is that if both are losses or only one is a loss and it is more than the capital gain, then the classification does not matter. A net capital loss does not need a classification.
Capital Losses:
Every year, you can deduct up to $3,000 of capital losses from your taxable income. You can also carry forward all capital losses indefinitely.
Example:
Scenario 1: In 2015, John sold stocks for a loss of $45,000 on December 10, 2015. John had no other passive income during the year. John also has a taxable income of $75,000 before incorporating the capital loss rules. Since the rules state that you can deduct up to $3,000 of capital losses each year, John would have taxable income of $72,000 and would be able to carry forward the rest of the capital loss of $42,000 indefinitely.
Scenario 2: It is now 2016 and John has carried forward his previous capital loss of $42,000. Later in 2016, John sold more stocks, that were held for 2 years, for a gain of $58,000. Like last year, John has a taxable income of $75,000 without considering capital gains and losses. After netting the previous capital losses with the capital gains that happened during the current tax year, John will end up with a long-term capital gain of $16,000. This long term capital gain will be taxed at the capital gain rate of 15% which would equate to $2,400 of taxes while his other income of $75,000 will be taxed at the ordinary tax rate for his specific tax bracket.
