What are capital gains?
Capital gains are profits made from the sale of real estate, investments and personal property. The Internal Revenue Service (IRS) classifies capital gains according to the length of time the taxpayer owned the property. Short-term capital gains refer to profits made from selling assets owned for one year or less, while profits earned on assets owned for more than one year are considered long-term capital gains.
Although many people associate the term with stocks and bonds, capital assets are anything an individual owns and uses for personal and investment purposes. This includes houses, furniture, coin collections, precious metals and jewelry.
According to the IRS, taxpayers must report and pay taxes on all capital gains. There is a capital gains tax exemption for the sale of a primary residence. As long as an owner lived in her primary residence for at least two of the last five years and hasn’t used the exemption within the past two years, she doesn’t have to pay capital gains taxes on the profit earned from the sale.
The IRS treats short-term capital gains as regular income and calculates the taxes due, using the taxpayer’s filing status and adjusted gross income. Long-term capital gains generally have a lower tax rate than short-term gains, capped at 20 percent in the highest tax bracket. Most taxpayers qualify for the 15 percent tax rate, and those with low incomes sometimes pay no taxes on capital gains.
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Capital gains example
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000. Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket. Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.