What Is a Capital Gain?
Let me explain what a capital gain really is. It's the increase in the value of a capital asset that you realize when you sell it. You get a capital gain if you sell something for more than what you paid for it. The IRS taxes these gains under specific conditions, so you need to know this if you're dealing with investments or personal assets.
Almost anything you own counts as a capital asset, from stocks and bonds to real estate, or even personal items like furniture or a boat. Keep that in mind when you're thinking about selling.
How Capital Gains Work
Capital gains represent the rise in an asset's value, and you typically realize them when you sell. You'll often see this with investments like stocks or funds because of their price fluctuations, but it applies to any security or item sold above its original cost, such as a home, vehicle, or collectible.
These gains split into short-term, for assets held a year or less, and long-term, for those held longer. You must report both on your tax return. If you're a day trader or frequent online trader, pay close attention to this distinction.
Realized gains create a tax event, but unrealized gains—those paper increases in value without a sale—aren't taxable. On the flip side, a capital loss happens when you sell below cost, which can offset gains.
Capital Gains Tax
Taxes on short- and long-term gains differ, and smart investing can minimize your bill. Short-term gains get taxed as ordinary income based on your filing status and adjusted gross income.
For long-term gains, rates are lower: 0%, 15%, or 20%, depending on your income and filing status. These thresholds adjust yearly for inflation. Some assets like collectibles hit a 28% max, and real estate can reach 25%.
There are exceptions: you can't deduct losses on personal items like your home or car, but selling your primary home exempts the first $250,000 of gain (or $500,000 for couples). High earners might face an extra net investment income tax.
Assets Eligible and Ineligible for Lower Tax Rates
- Eligible assets include stocks, bonds, jewelry, cryptocurrency (including NFTs), homes, household furnishings, vehicles, collectibles, timber, and fine artworks.
- Ineligible assets include business inventory, depreciable business property, real estate used by your business or as a rental, copyrights, patents, inventions, and literary or artistic compositions.
Capital Gains and Mutual Funds
If you invest in mutual funds, they must distribute realized capital gains to shareholders each tax year, often at year-end. You'll receive a 1099-DIV form showing the amount and type of gain.
Undistributed long-term gains come on Form 2439. These distributions drop the fund's net asset value but don't affect total return. Before investing, check a fund's capital gains exposure—the percentage of unrealized gains—to avoid unexpected taxes.
Example of Capital Gains
Consider this scenario: suppose you bought 100 shares of a stock like Amazon at $350 each on January 30, 2020, and sold them at $833 each on January 30, 2024. Ignoring fees, your gain is $48,300.
If you're single with $80,000 taxable income, that qualifies for a 15% long-term rate, so you'd owe $7,245 in taxes. This shows how holding periods and income levels directly impact your tax bill.
Frequently Asked Questions
You might wonder what qualifies as a capital gain—it's any sale of a capital asset above your purchase price. Short-term gains tax as ordinary income, long-term at lower rates.
A net capital gain is when long-term gains exceed short-term losses, potentially at a lower tax rate. To lower taxes on your house, live there over two years and track improvements to boost your cost basis.
The Bottom Line
Capital gains are profits from selling assets like stocks, bonds, or real estate at a gain. The lower taxes on long-term gains benefit many, including investors and homeowners, and losses can reduce your tax bill. If you hold assets you might sell, understand these rules to manage your taxes properly.
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