Tax on Long-Term Capital Gains
When you sell a capital asset for profit, such as a rental property or classic car, the tax implications are always less expensive when you report it as a long-term capital gain rather than short-term. The reason is because the IRS imposes ordinary income tax rates on your short-term gains, but the long-term gains are subject to the capital gains tax rates, which are always lower. However, to report a transaction as a long-term gain, you must first evaluate your holding period.
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How to Calculate
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Prior to assessing whether your holding period is sufficiently long to warrant reporting the transaction as long term, you must first assess how much gain to report. You calculate the gain as the price for which you sell the asset less your tax basis. The tax basis of an asset always includes its purchase price; however, for some assets, the tax basis increases for additional costs. For example, if you sell shares of corporate stock, you can increase the tax basis by the commissions your broker charges for both the buy and sell trades. And if it’s your personal residence, you increase your tax basis for the settlement costs you pay at closing, such as title insurance and lawyer fees.
Holding Period
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Your holding period for a capital asset refers to the length of time you own it before selling it. All property you own for one year or less as of the sale date results in a short-term capital gain or loss. If you own the asset for more than one year, you report it on Schedule D as a long-term capital gain or loss.
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Losses Reduce Gains
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Just because you report a long-term capital gain doesn’t necessarily mean you will have to pay income tax on it. Regardless of the holding period for each transaction you report on Schedule D, the IRS allows you to net your capital gains and losses, meaning you can reduce your taxable gain with all capital losses. If your losses exceed gains, you will not owe capital gains tax for the year. However, if your gains exceed losses, only the remaining gains that relate to long-term transactions are subject to the lower rates of tax.
Comparing Tax Rates
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When you report a net long-term capital, which means your long-term capital gains exceed all capital losses from the current and prior tax years, the maximum tax rate the IRS will impose is 15 percent. In contrast, your short-term capital gains that require a tax payment are subject to the ordinary income tax brackets that your employment and business income is subject to. For example, as of publication, if you report taxable income of $85,000 and use the single filing status, your marginal tax rate is 28 percent. This means that all taxable income you report between $83,601 and $174,400 is subject to the 28-percent rate. As a result, if you increase your taxable income for a short-term capital gain of $10,000, you will pay $2,800 in taxes on it because of your marginal rate.
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