You’ve probably heard of capital assets. But what exactly are they? How do they relate to capital gains and losses? And how do they affect your taxes? Read on to answer all your burning questions on capital assets, capital gains, and capital losses.
What is a capital asset?
For tax purposes, a “capital asset” refers to almost everything you own and use for personal purposes, pleasure or investment. That means that your home, household furnishings, stocks and bonds, and investment properties are all capital assets.
What are capital gains and losses?
A capital gain or loss is the difference between what you paid for a given asset, and what you sell it for. When you sell a capital asset for profit, that’s a capital gain. When you sell a capital asset for less than you paid for it, that’s a capital loss.
Long-term vs. short-term
All capital gains and losses are categorized as either short-term or long-term. What differentiates short-term and long-term capital gains and losses? It all depends on how long you held onto a given asset.
If you held onto a capital asset for more than one year, your capital gain or loss is considered long-term. If, on the other hand, you held the asset for one year or less, your capital gain or loss is short term.
To break it down even further, capital losses work as follows:
- If you held an asset for one year or less and then sold it for less than you paid for it, that’s a short-term capital loss.
- If you held an asset for more than one year and then sold it for less than you paid for it, that’s a long-term capital loss.
And the same is true for capital gains:
- If you held an asset for one year or less and then sold it for more than you paid for it, that’s a short-term capital gain.
- If you held an asset for more than one year and then sold it for more than you paid for it, that’s a long-term capital gain.
Do capital assets affect your taxes?
Simply put, yes! You do have to report your capital gains and losses on your taxes. Generally speaking, the IRS considers capital gains to be taxable income, and capital losses are tax deductible.
Let’s dig a little deeper.
How do you calculate your net capital gains and losses?
First, categorize your capital gains and losses based on whether they’re short-term or long-term.
Net short-term gains and losses
Add up all of your short-term capital gains and subtract from that figure your short-term capital losses. If the resulting figure is positive, you have netted a short-term capital gain. If the resulting figure is negative, you have netted a short-term capital loss.
Net long-term gains and losses
Likewise, add up all of your long-term capital gains and subtract your long-term capital losses. If the resulting figure is positive, you netted a long-term capital gain; and if it’s negative, that’s a long-term capital loss.
Can you offset long-term gains or losses with short-term gains or losses?
If one figure is a net gain and the other is a net loss, you can use them to offset each other. Why would you do so? Well, you’ll have to pay taxes on your net capital gains. If you subtract your losses from your gains, that’s less income to pay taxes on.
How do capital gains affect your taxes?
You’ll have to report your capital gains as income and pay taxes on them accordingly. The tax rate you pay on capital gains depends on your tax bracket. In the 2018 tax year, the following tax rates applied to capital gains:
|Income Tax Bracket||Short-Term Capital Gains||Long-Term Capital Gains|
Note that there are some exceptions to these rates for niche types of capital gains. For example, collectible assets like antiques and fine art are typically taxed at a flat rate.
SuperMoney Tip: When selling capital assets, keep in mind that the tax rate for long-term capital gains is significantly lower than the tax rate for short-term capital gains. If you’ve owned an asset for 390 days and are ready to sell, consider waiting a week to secure a lower tax rate on your earnings.
How do capital losses affect your taxes?
You can deduct capital losses from your taxable income, up to a maximum of $3000 (or $1500 if you’re married and filing separately). However, this only applies to losses from investment property — you cannot deduct losses from the sale of personal property.
Also, capital losses can carry over to the following tax year. That means that if your losses exceed the maximum deduction of $3000, you should take the maximum deduction and carry over the rest.
Looking to calculate your capital gains and losses? Form 8949 (Sales and Other Dispositions of Capital Assets) can help. Or click here to see the IRS’ thorough breakdown.
Capital gains and losses can complicate the already-difficult process of filing your taxes. If you need help, competent tax preparation software can streamline the process for you. To find the right tax prep solution for you, compare tax prep companies side-by-side and read honest user reviews below.