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Taxes / Capital Gains
By Kayla James
Updated July 5th. 2023 09:00 am ET.
What Is a Capital Gain?
The term capital gain refers to the increase in the value of a capital asset when it is sold. Put simply, a capital gain occurs when an individual or corporation sells an asset for more than what was originally paid.
Almost any type of asset that has been purchased can become o capital asset. For example, stocks, bonds, and real property all assets that can appreciate in value. Likewise, assets that have been purchased for personal use like furniture, boat, and paintings are also considered as assets.
Capital gains are realized when the individual or business sells an asset. By subtracting the original purchase price from the sale, the gain is realized. The Internal Revenue Service (IRS) taxes individuals and businesses on the gains. When dealing with certain investment classes, the tax owed will depend on how long the appreciated asset was held.
Understanding Capital Gains.
A capital gain represents the increase in the value of an asset. The gain is typically realized at the time the asset is sold. Because of the inherent price volatility of certain capital assets such as stocks and ETF's. gains can be realized. However, gains can also be realized on any security or possession that is sold for a price higher than the original purchase price, such as real property, furniture, or vehicle.
Capital gains fall under two categories:
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Short-term capital gains: Gains realized on assets that you've sold after holding them for one year or less.
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Long-term capital gains: Gains realized on assets that you've sold after holding them for more than one year.
Both short- and long-term gains must be claimed on an annual tax return.
Understanding the distinction between the two and factoring them it into investment strategy is important for day traders and others like kind professions.
Realized capital gains occur when an asset is sold, triggering a taxable event. Unrealized gains, sometimes referred to as paper gains and losses, reflect an increase or decrease in an investment's value but are not considered a capital gain that should be treated as a taxable event.
Capital Gain Tax Rates
The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than or equal to $41,675 for single and married filing separately, $83,350 for married filing jointly or qualifying surviving spouse or $55,800 for head of household.
A capital gain rate of 15% applies if your taxable income is more than $41,675 but less than or equal to $459,750 for single; more than $83,350 but less than or equal to $517,200 for married filing jointly or qualifying surviving spouse; more than $55,800 but less than or equal to $488,500 for head of household or more than $41,675 but less than or equal to $258,600 for married filing separately.
However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate.
There are a few other exceptions where capital gains may be taxed at rates greater than 20%:
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The taxable part of a gain from selling section 1202 qualified small business stock is taxed at a maximum 28% rate.
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Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28% rate.
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The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate.
Reminder: Net short-term capital gains are subject to taxation as ordinary income at graduated tax rates.
Special Capital Gains Tax Rules.
Certain types of stock or collectibles may be taxed at a higher 28% capital gains rate, and real estate gains can go as high as 25%. Moreover, if the capital gains place the income over the threshold for the 15% capital gains rate, the excess will be taxed at the higher 20% rate.
As well, certain types of capital losses are not deductible. If an individual sells their house or car at a loss, they will not be able to deduct the difference on their taxes. An individual will, however, be able to sell their primary home, with the first $250,000 being exempt from capital gains tax. The figure doubles to $500,000 for married couples.
Note: Individuals whose incomes are above these thresholds and are in a higher tax bracket are taxed 20% on long-term capital gains. High-net-worth investors may have to pay the additional net investment income tax, on top of the 20% they already pay for capital gains.
Assets Eligible for Capital Gains
Eligible Assets
Not Eligible Assets
Stocks
Bonds
Jewlery
Cryptocurrency (including NFTs)
Homes and Household furnishings
Business inventory
Depreciable business property
Real estate used by your business or as a rental property
Copyrights, Patents, and Inventions
Literary or Artistic Compositions
Vehicles
Collectibles
Timber
Assets Eligible for Capital Gains
Mutual funds that accumulate realized capital gains throughout the tax year must distribute these gains to shareholders.
Many mutual funds distribute capital gains right before the end of the calendar year.
Shareholders receive the fund's capital gains distribution and get a 1099-DIV form outlining the amount of the gain and the type—short- or long-term. When a mutual fund makes a capital gain or dividend distribution, the net asset value (NAV) drops by the amount of the distribution. A capital gains distribution does not impact the fund's total return.
Tax-conscious mutual fund investors should determine a mutual fund's unrealized accumulated capital gains, which are expressed as a percentage of its net assets, before investing in a fund with a significant unrealized capital gain component. This circumstance is referred to as a fund's capital gains exposure. When distributed by a fund, capital gains are a taxable obligation for the fund's investors.
How Do Mutual Funds Account for Capital Gains?
Mutual funds that accumulate realized capital gains must distribute the gains to shareholders and often do so right before the end of the calendar year.
Shareholders receive the fund's capital gains distribution along with a 1099-DIV form detailing the amount of the capital gain distribution and how much is considered short-term and long-term. This distribution reduces the mutual fund's net asset value by the amount of the payout though it does not impact the fund's total return.
How Are Capital Gains Taxed, and What Is a Net Capital Gain?
Again, capital gains can either be classified as short-term or long-term. Short-term capital gains, defined as gains realized in securities held for one year or less, are taxed as ordinary income based on the individual's tax filing status and adjusted gross income. Long-term capital gains, defined as gains realized from asset held for more than one year and is usually taxed at a lower rate than regular income.
An individual will realize a net capital gain as the amount by which net long-term capital gain (long-term capital gains minus long-term capital losses and any unused capital losses carried over from prior years) exceeds net short-term capital loss (short-term capital gain minus short-term capital loss). A net capital gain may be subject to a lower tax rate than the ordinary income tax rate.
Capital Gains Taxes and Various Business Structures.
A capital gains is the difference in price realized from assets that are divested for more than their original or adjusted cost basis. For most business structures as well as individual taxpayers, capital gains are treated more favorably than other forms of income.
Capital gains tax rates for companies are equal to the ordinary corporate income tax rate.
C corporations can deduct regular expenses from their ordinary income, but that’s not true with capital losses. Companies can only claim capital losses to offset capital gains. C-corps with an excess of capital losses versus capital gains are allowed under current tax laws to either carry those losses back three years or forward five years to offset any future realized capital gains. Any excess capital loss that remains after carrying it forward five years cannot be used and simply expires.
Investors are also incentivized to hold the QOZ investment for at least 10 years at which time any capital gains taxes on the QOZ itself entirely eliminated. However, Appreciation on the investment of an Qualified Opportunity Zone is not guaranteed. It is wise to work with an experienced advisor to do the necessary due diligence before selecting an QOZ fund
Further Reading
What You Need to Know About Capital Gains and Taxes.
United States
Corporate - Income Determination.
IRS Form 8949: Sales and Other Dispositions of Capital Assets,
How Capital Gains and Dividends Are Taxed Differently.
What You Need to Know About Capital Gains and Taxes.
