IRS Rules for Taxes on Long-term Capital Gains

Long-term capital gains appear on IRS Form 1040.

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Unlike men, not all income is created equal in the United States, at least under the Internal Revenue Service tax code. Long-term capital gains receive preferential tax treatment in the form of lower tax rates than short-term capital gains and ordinary income rates. Long-term capital gains aren't limited to investment income and also include profits on selling personal property.

Long-term Capital Gains

Long-term capital gains come from the sale of capital assets that you've held for more than one year. Capital assets include just about anything that you own for personal or investment use. Examples include your house, car, stock and mutual funds. Even that new furniture in your living room is a capital asset, though if you sell it, you can't use losses from the sale of personal property to offset long-term capital gains.

Calculating Gains

Calculate long-term capital gains by subtracting your basis from your net proceeds. "Basis" means what you paid for it, including things like brokers fees, freight and sales taxes. Say you buy a stock for $800 and pay a $9 transaction fee. Your basis is $809. Your net proceeds are what you get when you sell the item, after again accounting for transaction fees. If you later sell that stock for $917 and pay $8 in transaction fees, your net proceeds are $909, meaning you have a long-term capital gain of $100. Similarly, for personal property, if you buy a $500 sofa, pay $25 in sales taxes and $50 for shipping, your basis for the sofa is $575. If someone later pays you $600 for it, you'll have a $25 gain. If you received it as a gift or inherited it, the rules are a bit different.

Basis of Gifts

For gifts, your basis depends on the fair market value at the time of the gift and the value when the donor purchased it. If the fair market value is equal to or higher than the original purchase price when you receive a gift, you always take the donor's basis. If the fair market value is lower, you use the donor's basis as your own when figuring a gain, but the fair market value at the time of the gift as your basis if you're figuring a loss. For example, say your friend gave you a stock that he paid $200 for, but is worth $150 when you receive it. If you sell the stock for more than $200, your basis is $200. If you sell the stock for less than $150, your basis is $150. If you later sell that stock for anywhere between $150 and $200, you won't have a gain or loss.

Basis for Inheritances

When you inherit something, your basis is either the fair market value on the date of death or, if a special election was made, the alternative valuation date. If you inherited the property from a decedent who died in 2010, a different set of rules may apply if an election available only in that year was made.

Offsetting Losses

On your taxes, you can use other capital losses to offset your long-term capital gains. For example, if you have $10,000 in long-term capital gains from selling stock but you took a $1,000 hit on another trade, you'll only pay taxes on $9,000 of long-term capital gains.

Timing and Rates

Long-term capital gains aren't taxed until you sell the asset. For example, your stock could double in price, but if you don't sell it you won't have to pay taxes on it -- at least not yet. In addition, long-term capital gains are taxed at a lower tax rate. For example, in 2012 the maximum tax rate is 35 percent for ordinary income, but long-term capital gains are taxed at a maximum of 15 percent.