When you sell a “capital asset”, the sale usually results in a capital gain or loss.
So, what is a capital asset? Typically, a capital asset is any property held by a taxpayer except for inventory, accounts or notes receivable from a trade or business, depreciable property used in a trade or business, real estate used in a trade or business (including rental property, certain commodity financial instruments and hedging transactions), supplies used in a trade or business, certain future payments rights, and self-created copyrights including literary and musical compositions. Capital assets would include your home, your car and your investments such as stocks and bonds.
A capital gain or loss is the difference between your basis and the amount received when you sell an asset. The basis of an asset is usually your purchase price, although sometimes there may be other ways to determine basis. Examples include inheritances, trades or exchanges.
Capital gains and losses are either long or short term, depending on how long you held the property. If you held the property for more than one year, your gain or loss is long term. If you held it for one year or less, then the property is short term.
A gain on the sale of personal property, such as your personal home, is taxed as a capital gain. A loss on the sale of personal property used for personal purposes is not deductible. Deductible losses are allowed only for a business, investment, casualty or theft losses.
The tax rate you will pay for a capital gain depends on the holding period, type of capital asset, and the taxpayer’s ordinary income tax bracket. Short term capital gains are usually taxed at ordinary income tax rates. You will pay from 0 percent, 15 percent, 20 percent, 25 percent and, in some instances, 28 percent on long term capital gains. Starting in 2013, you may also be subject to the Net Investment Income Tax. The NIIT applies at a rate of 3.8 percent to certain net investment income of individuals, estates and trusts above statutory threshold amounts. As a side note, I have seen where large capital gains have also subjected the taxpayer to the Alternative Minimum Tax.
Capital losses are netted, short term losses against short term gains and long term losses against long term gains. If your capital losses exceed your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year, or $1,500 if you are married and file a separate return. If your total net capital loss is more than the limit, you can carry over the losses to next year’s tax return and start the process all over again.
Finally, when reporting your capital gains and losses on your tax return you must file Form 8949, Sales and Other Dispositions of Capital Assets. You also need to file Schedule D, Capital Gains and Losses. Because of the complexity of the tax law, I always advise seeing a tax specialist to help you file your tax return correctly.