"Capital gains," whether associated with real estate or not, is the term used by the IRS to denote a profit made on an investment. The difference between short- and long-term capital gains is the length of time a taxpayer holds the investment. If there is a loss of investment, the term is capital loss. Real estate profits are most often classified as long-term capital gains.
Capital gains arise from the successful sale of investments. A common investment that results in capital gains or losses is stock. Investment real estate includes a rental property -- residential, commercial or industrial. A personal residence is not an investment property under IRS rules.
Capital Gains and Income
Prior to 1922, regular income, such as wages or business profit, was taxed in the same way capital gains were; that is, the same tax rate was used and that rate depended on a taxpayer's total income. From 1923 to 2012, long-term capital gains have been subject to a flat tax which, with the exception of the period from 1988 through 1990, has been substantially lower than the highest regular income rate.
Short-term and Long-term
"Short-term capital gains" applies to profits from investments that are sold within a year of the purchase. "Long-term capital gains" applies to profits on investments sold after having been held one year or longer. Short-term capital gains are taxed at the same rate as regular income. The higher the income, the higher the tax rate. In 2012, long-term capital gains are taxed at a flat rate of 15 percent of the realized profit. Because most real estate investments are held at least a year, real estate capital gains are usually long-term gains.
What Is a Gain?
A capital gain isn't simply the difference between sales price and purchase price, especially in real estate. The cost of improvements to the property, such as additions and renovations, of newly purchased appliances, and closing costs in the purchase and sale process are all subtracted from the sales price to determine capital gain.
Reporting Capital Gains
Report capital gains and losses on Schedule D, Capital Gains and Losses, and then transfer the amount to line 13 of Form 1040.
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