What is a Capital Gain?

The concept of capital gains is a specification in the Internal Revenue Code that gives preferential treatment to the sales of certain specified assets. Why is this important? Because, if you buy a specified item and hold it for the specified period of time, the proceeds on the sale of the item are taxed at a rate that is preferable to the rate of many of the tax rates in effect at the time. Specified items include stocks, bonds, real estate and certain other securities, although there are some exceptions that are explained in the Internal Revenue Code.

For example, after 2011, the long-term capital gains tax rate will be 20% (10% for taxpayers who are in the 15% tax bracket). That compares to many other rates, which would be applicable to the sale of the capital asset if the special capital gains tax rates were not applicable. Many of these rates are in excess of 20%, with the highest tax rate currently over 40%. Thus, it is to any taxpayer's benefit to try to make sure their income from the sale of property is classified as a long-term capital gain with a 19.6% savings over the top tax rate.

Are Capital Gains Only for the Wealthy?

Absolutely not, particularly with today's stock market gains, millions of Americans may now fall into the category of taxpayers that can take advantage of this beneficial tax rate. Remember, regardless of your income level, you are entitled to take full advantage of any applicable Tax Code provision.

How Can Capital Gains Provisions Help Me?

Remember, ordinary income is usually the highest tax rate that applies where no other special Tax Code provision applies. Thus, it is often advantageous to qualify for any special tax treatment that allows either a lesser tax rate, or an exemption from taxes completely. The favorable tax rate of capital gains can work to allow you to classify certain income on your tax return as capital gains, instead of ordinary income, resulting in a substantial savings of taxes in some cases.

What are Capital Assets?

Millions of taxpayers are holding items, or have bought and sold items, which qualify as a Capital Asset. These may include anything you own or use for personal use, or for investment purposes - jewelry, stocks, bonds, and some types of household furnishings. Some sales of real estate may be classified as capital assets, but other tax code provisions may apply.

How Does this Capital Gains Treatment Work?

You are responsible for making a determination of whether your sale of a specified asset, such as a stock, is a capital gain or loss, or an ordinary loss. In calculating capital gains, you can offset gains with losses plus an additional $3,000, but you must match capital gains with capital losses, and ordinary gains with ordinary losses. The two cannot be combined to allow an offset.

An example: George has $20,000 of capital losses and $10,000 of capital gains. Capital losses for this tax year can only be $13,000 [$10,000 (the extent of the capital gains) plus $3,000 (allowed above gains by the tax code)]. The remaining $7,000 loss can be carried over, to the next tax year depending upon next year's tax code provisions.

In our example, if George had $10,000 of capital gains and $13,000 of ordinary losses, the entire amount of ordinary losses could be utilized to save taxes in the current year. However, they could not be offset by the $10,000 of capital gains and the capital gains tax would apply to the $10,000 of George's gain.

Need for Advice

Capital gains can be a difficult area to understand, although a proper understanding can result in substantial tax savings. Proper understanding of this area can lead to proper tax planning, which can help save money on taxes. If you are a taxpayer who has bought and sold some of the items that we have discussed as capital assets, you ought to invest in some personal tax advice. This personal advice may result in substantial tax savings, either this tax year, or perhaps help to plan for savings before the next tax year. Capital gains are not just for the wealthy.

If you have any further questions about capital gains, please contact member services!

Posted in: Tax