When it comes to your taxes, your capital gains are taxed in two different categories: ordinary gains and long-term capital gains. You can also generate ordinary gains from selling noncapital assets. Understanding how taxes are structured helps you plan not only for the amount you're going to owe, but also for ways you can lower your tax burden in future years.
Selling Investment Property
Capital gains are profits from selling capital assets -- things that you hold for personal use or investment purposes. These include things like your home, mutual funds and the art in your home. Any time you sell a capital asset before you've owned it for more than a year, the gain is taxed at your ordinary income tax rate. If you hold it for more than a year, your gain is taxed at the lower capital gains rate.
The sale of noncapital assets also results in ordinary gains for tax purposes. Noncapital assets include inventory or other property held out for sale in your trade or business and depreciable property used in your trade or business or as rental property. For example, if you flip houses, the homes that you buy and sell count as inventory, rather than a capital asset. Other noncapital assets include accounts or notes receivable you acquire in the ordinary course of your business as well as copyrights or artistic property you personally created and supplies you regularly use or consume in your trade or businesses. For example, if you write a book and sell the rights to it two years later, your proceeds are ordinary gains.
Ordinary gains are taxed at your standard income tax rate, which is the same rate that applies to your salary or wages. As your income increases, you move into increasingly higher income tax brackets, and your short-term capital gains are taxed at that high income tax rate. For 2013, there are six income tax brackets: 10 percent, 15 percent, 25 percent, 28 percent, 36 percent and 39.6 percent. By comparison, long-term capital gains are taxed at a rate of 20 percent as of 2013.
Net Investment Income Tax
Starting in 2013, the Internal Revenue Code imposes an additional 3.8 percent tax on your investment income when your modified adjusted gross income exceeds the threshold for your filing status. Your net investment income includes not only your short-term and long-term capital gains, but also rental income, interest and dividends, even though some of those gains are already taxed at the higher ordinary gain rates. As of 2013, the threshold is $250,000 if you're married filing jointly, $200,000 if you're single and $125,000 if you're married filing separately.
- API Exchange: Understanding the Impact of Tax Treatment
- Internal Revenue Service: Topic 409 -- Capital Gains and Losses
- Georgia State University: Basic Tax Rate Concepts
- IRS: Net Investment Income Tax FAQs
- IRS: Publication 225 -- Farmer's Tax Guide
- IRS: Publication 544 -- Sales and Other Dispositions of Assets
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