Capital gains tax is what you owe Uncle Sam when you sell something you own at a profit. Income tax is what you pay on most other money you make, often referred to as ordinary or regular income.
A capital gain may be either long term or short term. Short term means you owned the property for a year or less. Long term applies to something you owned for more than a year. This matters because any profit you make from selling something you owned for more than a year is a long-term capital gain, and tax rates on long-term capital gains are lower than rates that apply to ordinary income.
Types of Income
- Ordinary income that is subject to income tax includes salaries, wages, tips and other compensation for work. Interest, pension payments, taxable distributions from retirement plans and self-employment earnings are all considered ordinary income.
- Capital gains income is profits from the sale of investments like stocks, bonds or a home. If you make a profit from the sale of other personal property like a car or furniture, it counts as a capital gain.
- Property held for business use, while still owned by you, can generate rental income that falls under ordinary income. If you sell the business property, any gains above your property's adjusted cost basis qualify as capital gains for tax purposes.
Income Tax Rates
Federal income tax is levied on ordinary income in a series of increasing percentage rates called marginal tax brackets. As of the time of publication, the first dollars of ordinary income that you earn are taxed at 10 percent. As your income goes up, higher rates apply. The next bracket is 15 percent, followed by 25 percent, 28 percent, 33 percent, 35 percent and, finally, 39.6 percent.
The dollar ranges of tax brackets vary depending on your filing status. For example, the 10 percent tax bracket for single taxpayers in 2015 was capped at $9,225, and capped at $18,450 for a married couple filing a joint return. The dollar thresholds for each tax bracket change each year because the Internal Revenue Service makes an annual adjustment to offset inflation.
Capital Gains Tax Rates
Capital gains tax rates apply only to long-term gains. Short-term gains are taxed just like ordinary income. The tax rate you pay on long-term capital gains depends on which income tax bracket you are in. The capital gains rates in 2015 were:
- Zero for taxpayers in the 10 and 15 percent income tax brackets
- 15 percent for people in the 25 percent to 35 percent tax brackets
- 20 percent for a taxpayer in the 39.6 percent bracket
- A higher capital gains rate of 28 percent applies to profits from the sale of precious metals and collectibles.