Home > Personal Finance > Taxes > What Is Capital Gain?

Capital Gains -- you've got the money -- now you have to pay

Jan 29 '02 (Updated Apr 26 '03) Write an essay on this topic.

The Bottom Line You have a capital gain when you sell something for more than you paid for it. They are taxable, but often at a lower rate than "ordinary" income.

The key word is gain. You have a capital gain when you sell something for more than its basis, generally what you paid for it.

Of course, there are exclusions and inclusions. This is income tax, after all.

Exclusions

Gains on your main home (the IRS has given up trying to decided whether it's "principal" or "principle" residence) are excludable, if you've owned the home for 2 of the past 5 years and lived in the home for 2 of the past 5 years, up to $250,000 ($500,000 if married filing joint). You can only use the exclusion once every 2 years. You can prorate the exclusion (if you don't meet the full 2 year requirement) if you sell the home for employment or job-related reasons. Any depreciation taken on the home since enactment (5/5/97?) is reincluded as unrecaptured section 1250 gain (see below).

You can choose not to take the exclusion. There are plausible reasons for doing so, for example, if you own two homes "A" and "B", you lived in "A" for 3 years, then "B" for 2 years, and sell both, you would choose to exclude the gain on the property with the higher gain, even if it's not the first sold.

Gains and losses are usually disregarded on sales between husband and wife, and on property transfers incident to a divorce.

Gains and losses on sales of business inventory are ordinary gains and losses, rather than capital gains and losses.

If you exchange your business property for property with the same use, you may be able to defer the gain or loss.

If you have gain on qualified small business stock, half of it is excluded and half is 28% property (see below under How is it taxed?).

Inclusions

If you write an option, and it expires unused, you have a capital gain.

Short sales (when you sell a stock, and then buy it back) can result in either a gain or a loss.

Mutual funds are required to allocate their long-term capital gains to their subscribers. This is usually based on the ownership interest on a certain day in December. (Timing advice -- don't buy non-"tax advantaged" mutual funds in November or early December.)

There is a one-time option on your 2002 tax return to declare property sold and repurchased on January 2, 2001. Gains cannot be excluded under any of the provisions above, and losses are lost. For a reason for doing this, refer to the new 18% tax bracket (below).

How is it taxed?

Net short term capital gains are taxed as ordinary income. For long term capital gains:

Collectibles, gold bullion, and certain other non-preferred assets are called "28% property" and the gains are taxed at a maximum of (duh!) 28%, if you're in a higher tax bracket. (I haven't yet been able to decipher the worksheets in the 1040 schedule D instructions. This gain might be taxed at 28% even if you're in the 27% tax bracket.)

Unrecaptured section 1250 gain (the part of the gain on real property allocated to depreciation taken) is taxed at a maximum of 25%.

Other long term capital gain is taxed at 10% (8% for 5-year gain) for that portion in the 10-15% tax bracket, and 20% (18% for 5 year gain if bought in 2001 or later).

In spite of the 28% taxation of property when your in the 27% tax bracket, your tax cannot be increased above what it would be if all your capital gain was considered ordinary income.

There is an attempt to make at least the 20% tax rate not subject to Alternative Minimum Tax. (See, for example, my review on AMT for more discussion of AMT, although I didn't report on this capital gains exclusion.)

Read all comments (2)|Write your own comment

Write an essay on this topic.

Share with your friends