What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Capital Gains Tax Rates vs. Ordinal Income Tax

Original post by Lisa Bigelow of Demand Media

Stock market gains are capital gains.

Just about everything you own is an asset. Your home, car, personal belongings and investments are all assets. When you sell an asset, you usually have to report the sale to the Internal Revenue Service, regardless of whether you made a profit or loss. Depending upon what you sold, you'll need to pay either income tax or capital gains taxes; and in some cases you may not owe any tax at all.

Capital Gains

Calculate your net capital gain. The net capital gain is the amount that your net long-term capital gain for the year is greater than what you'll claim in short-term capital losses and long-term capital loss carryovers combined. Usually, the net long-term capital gain is taxed at a rate of15 percent, although some assets are taxed differently. For example, gains from selling qualified small business stock are taxed at 28 percent, as are net capital gains from collectibles.

Capital Losses

If you sustain a capital loss, you can deduct it from your taxable income, which lowers the amount of income tax you owe. Although you'll only be able to deduct a maximum of $3,000, if you sustained a loss greater than this amount you can carry over the loss in future years. Capital gains and capital losses are reported on Form 1040's Schedule D. Although home sales usually aren't reported as capital losses, unless it was an investment property. Primary residence sales are treated differently.

Ordinary Income Taxes

The proceeds of an asset's sale are sometimes added to ordinary income and are taxed at your ordinary income tax rate. Your income tax depends on your adjusted gross income (AGI). In 2011, the highest income tax rate is 35 percent of AGI, but the tax bracket you're in depends on your filing status as well as income. For example, a single taxpayer who earns between $34,000 and $82,400 is in the 25 percent bracket. However, this bracket is raised for those who are married filing jointly -- between $68,000 and $137,300. In general, capital gains taxes are less than income taxes.

A Big Exception

If you are planning to sell your primary residence and are concerned about how the potential gain will affect your income taxes, your gain may be tax free. The IRS often excludes the first $500,000 for married couples on gains from the sale of your primary residence ($250,000 for single filers). You'll need to have owned and lived in the home for at least two years. If you think your gain will be higher, you can reduce the gain by adding sale and improvement expenses to your original cost.

                   

References

About the Author

Lisa Bigelow is a freelance writer and editor. She is a former financial analyst and worked at a college, a media company and an investment bank. She also contributes to Patch. Lisa graduated from the State University of New York, Plattsburgh with a Bachelor of Arts in mathematics.

Photo Credits

  • Hemera Technologies/PhotoObjects.net/Getty Images

Advertisement