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What Are Capital Gains?

  • Writer: Jennifer Wills
    Jennifer Wills
  • Jun 9
  • 2 min read

A capital gain is the increase in a capital asset’s value that is realized when the asset is sold. Examples of these assets include:

 

Most types of assets are capital assets. The IRS taxes individuals on capital gains under specific circumstances.

 

Short- and Long-Term Capital Gains

Capital gains fall into two categories:

  • Short-term: Gains realized on assets sold after holding them for one year or less.

  • Long-term: Gains realized on assets sold after holding them for more than one year.

 

Short- and long-term capital gains must be reported on your annual tax return:

  • Realized capital gains trigger a taxable event.

  • Unrealized gains, or paper gains, reflect an increase in the value of an investment that has not been sold, and are not taxable.

  • A capital loss is incurred when a capital asset is sold for less than its purchase price.

 

Capital Gains Tax

Short-term capital gains are taxed as ordinary income at a rate based on an individual's tax filing status and adjusted gross income (AGI). Long-term capital gains are taxed differently:

  • Long-term capital gains are taxed at lower rates than ordinary income tax rates.

  • The tax rates for long-term gains are 0%, 15%, and 20%.

  • Certain assets, such as collectibles, can be subject to a maximum tax rate of 28%, depending on the investor’s taxable income and filing status.

  • The 0% and 15% rates apply as long as income stays at or under a maximum amount that is adjusted annually to keep pace with inflation.

  • If an investor has more income than the maximum amount allowed for the 0% rate, the gain is taxed at the 15% rate.

  • If the investor has more income than the maximum amount allowed for the 15% rate, the gain is taxed at 20%.

 

Special Capital Gains Tax Rules

Special capital gains tax rules include the following:

  • Real estate gains can have a tax rate of up to 25%.

  • Types of stock or collectibles can have a tax rate of up to 28%.

 

Certain types of capital losses are not deductible:

  • If you sell your house or car at a loss, you cannot treat it as a tax deduction.

  • When you sell your primary home, the first $250,000 for a single person, $500,000 for married couples, is exempt from capital gains tax.    

  • High-net-worth investors might pay an additional net investment income tax.

 

Capital Gains and Mutual Funds

Mutual funds that accumulate realized capital gains throughout the tax year must distribute these gains to shareholders:

  • Many mutual funds distribute capital gains right before the end of the calendar year.

  • Shareholders who receive a distribution will get a 1099-DIV form detailing the amount of the capital gain and the type.

  • Undistributed long-term capital gains are reported to shareholders on Form 2439.

  • When a mutual fund makes a capital gain or dividend distribution, the net asset value (NAV) drops by the amount of the distribution.

  • A capital gain or dividend distribution does not impact the fund's total return.

 

*This information is for educational purposes only.

 

Let me know in the comments which personal finance topic I should write about next!

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