What Are Capital Gains and How Are They Taxed?

What are capital gains? Do they apply to me, and if so, how are capital gains taxed? This post explores what capital gains are and how they are taxed.

When you think about taxable income, you probably think of earned income, such as wages or self-employment pay. You don’t always include the car you sold on Facebook Marketplace or the stocks you cashed in on Robinhood. From the perspective of the IRS, however, anytime you sell an item and collect money, it is considered a taxable event.

Fortunately, you seldomly have to pay tax on the entire amount of proceeds you receive in a given year. Typically, you’re only responsible to pay tax on the gain. A gain is the dollar amount you made on a sale. This is calculated by taking the amount you received as payment for the asset and subtracting the amount you originally paid for it. For example, if you bought one ounce of silver for $150, and you sell it for $300, you have a gain of $150 ($300 – $150 = $150).

The amount you originally paid for an asset is generally your tax basis. However, in certain cases it can be more complicated. There are two ways to change your tax basis. First, you can take depreciation deductions for the asset and your tax basis is reduced by the deductions. If you choose to do so, a lower tax basis means a higher taxable gain when you sell the item. Second, if you make improvements to the asset the amount you spend increases your tax basis. In that case, a higher tax basis typically means a lower taxable gain when you sell the asset.

For example, if you have a rental house and add new countertops in the kitchen, the amount you spend on the countertops increases your tax basis. Your tax basis adjusted for depreciation deductions, improvements, and any other adjustments is called your adjusted basis.

Most personal items you own, such as a car, stocks, or real estate, are assets that can be subject to capital gains tax. These are known as capital assets. If you own a business, not all business assets are considered capital assets. Generally, a capital asset for a business is property that is expected to generate value over a long period of time. This can include buildings, computers equipment, machinery, and vehicles.

Capital gains can be a very beneficial way of generating income, as they are typically taxed at a more favorable rate than standard salary or wages. However, this is not true in every case as not all capital gains are the same. Capital gains are broken down into two categories: long-term and short-term.

A short-term capital gain refers to any profit made from the sale of an asset you owned for one year or less. This type of gain does not benefit from any special tax rate and is taxed the same as ordinary income. A long-term capital gain refers to any profit made from the sale of an asset you owned for more than one year. This type of gain benefits from a reduced tax rate.

If you have long-term capital gains, the tax rate will depend on your income bracket. For example, if you earn less than $40,000/year (filing single), your capital gains tax rate may be zero. If your taxable income is above $441,451/year, your capital gains tax rate is going to be 20%, for now.

This McNeelyLaw LLP publication should not be construed as legal advice or legal opinion of any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.