You might have heard the myth that the tax code is over 70,000 pages long. Although untrue, it’s easy to understand why it’s such a widely accepted belief.
Very few people have the patience to read through the collection of resources on the Internal Revenue Service (IRS) website. But there’s good news: the portion of the tax code dedicated to capital gains tax is 100 pages. Whether you’re filing capital gains taxes using a preparer or on your own, you should have a basic understanding of capital gains tax law before you proceed.
What Are Capital Gains and Capital Losses?
In its simplest form, a capital gain is any profit made from the sale of an asset. Assets include stocks, businesses, land, cars, art, jewelry and more. A capital loss is just the opposite. You’d have a capital loss when you sell an asset for less than its base price. Investors can incur capital gains and losses from their investments, but the net gain or loss matters the most for your total capital gains tax. If you end up with capital gains, you will owe taxes. However, you should still show losses on your tax return. Net losses are tax deductible and can work alongside tax credits to minimize your bill.
When Do I Have to File for a Capital Gain or Capital Loss?
Filing financial transactions is important to avoid tax complications down the road. The following are scenarios when you have to file for capital gains or losses.
A general rule of thumb is you should file whenever you exchange an asset for money. Below are the most common taxable exchanges.
- Profits from mutual funds, bonds, stocks and other investments
- Selling real estate but not your primary residence
- Gifted or inherited property
You will have to provide your cost basis and the price during the sale. For instance, if you bought a stock for $100, your cost basis for that share is $100. If you sell the stock for $105, you have to report that sale price along with the $5 capital gain.
Your total capital gain from selling multiple shares depends on which shares you sell. Each stock order is part of a separate lot, and each lot has a different cost basis. The difference between your cost basis and the selling price determines your capital gain or loss. Many brokerage firms provide this information for you in an annual report if you trade stocks, mutual funds and other assets.
- Like-kind exchanges or 1031 exchange: The exchange of two pieces of investment real estate that are of the same value — sometimes, the property from this must be held to be considered nontaxable
- Exchange expenses: Any closing costs in real estate, brokerage commissions and attorney fees
- Property plus cash: If you traded property and paid cash for the difference in price such as trading in your old car and paying the $12,000 difference for a new car
The taxation of other events can get more complicated. You may want to consider reaching out to a professional tax adviser to determine the capital gains tax — if any — for these transactions.
- If you had significant investment income for the tax year, you may be subject to the Net Investment Income Tax
- Traded commodities
- Engaged in wash sales
- Are not sure whether you need to file for any certain activities
What Year Do I File Capital Gains Tax?
Generally speaking, you count capital gains in the year that the asset is sold, but there are exceptions. For example, if you bought your house in 2012 and sold it in 2022, you would file for the gain on your 2022 taxes.
Steps to File Capital Gains Tax
Ready to file? Follow the steps below.
Step 1: Gather Relevant Forms
Before you file, have relevant forms on hand. Most forms will be provided by a third party. They should send them by the end of January or mid-February, depending on the form. If you do not receive them by then, contact the third party — your broker, agent or mortgage company. Here are the most common forms you’ll need to file capital gains taxes:
- 1099-B: This details any money you made from a broker.
- 1099-DIV: If you made over $10 in dividends from an investment fund company, it will send you this form. If you cashed out your dividends, the company should send you a 1099-B as well.
- 1099-S: If you purchased or sold real estate for over $600, you should get a 1099-S from the person or entity that closed the transaction.
- Any other evidence to prove improvements, depreciation and sales.
Once you have your documents together, you can get familiar with the IRS forms. You’ll report your information on the following:
- Form 8949: You’ll report sales and exchanges of any asset, including bonds, stocks, real estate and involuntary exchanges. If your number of exchanges exceeds the space on the page, don’t sweat it. You can fill out as many Form 8949s as necessary.
- Schedule D (Form 1040): Here, you’ll record your totals from your Form(s) 8949.
Step 2: Define Adjusted Basis of Your Assets
The basis is the original cost of an asset. You’ll get this information from your original purchase documents. You should also keep track of this yourself, just in case. The adjusted basis is the basis plus any fees, commissions or costs of improvement and minus any depreciation.
The 1099 forms should hold this information. Here’s an example. Say you bought 50 shares of Google stock at $100 per share. The cost basis is $5,000.
This can be true for gifted property, where you use fair market value at the time of the gift and the gift tax. Inherited property basis will be found using the fair market value at the time of death.
Step 3: Determine Holding Period
If you held your property, security or item for more than one year, it would be considered a long-term capital gain or loss. On the other hand, if you held it for less than one year before selling, it’s considered a short-term capital gain or loss.
The holding period starts on the day of the purchase and includes the day of the sale. If you have a 1099-B, this will be easy to determine. Your broker will list the classification per asset class in Box 2. This is important because they’re taxed at a different rate. The short-term capital gain rate is taxed at the regular income tax rates, and long-term capital gains are taxed at a lower rate.
Step 4: Figure Out the Proceeds From a Sale and Net Capital Gain or Loss
For the typical person claiming capital gains or capital losses, the 1099-B or 1099-S will provide enough information for you to determine the proceeds from the sale. On a 1099-B, the gross or net proceeds will be found in Box 1d. On a 1099-S, the gross proceeds will be in Box 2. Pretty simple.
Take note of the rest of the categories on these forms. You’ll need them to fill out the rest of your paperwork. You’re ready to check out Form 8949 and Schedule D (Form 1040.) Once you input your information from your 1099-B or 1099-S into Form 8949, it’ll start to make sense.
You will add all capital gains and losses and complete a worksheet if capital loss carryover applies to you or if you have a net capital gain or loss. Once you’re done, the form shows your capital gains or losses for the year. If you need additional help, check out the IRS guides to Form 8949 and Schedule D (Form 1040.)
Capital Gains Tax Rates
As mentioned above, capital gains are taxed differently if they are short-term or long-term gains. If you have a:
- Net capital gain or net long-term capital gains tax: If your long-term capital gains were more than your capital losses, you have a net capital gain. Net capital gain tax is a lower rate than short-term gains.
- Net short-term capital gains tax: Short-term capital gains are taxed as regular income. You’ll pay taxes at graduated rates.
Determining Your Capital Gains Tax
Once you have all of your paperwork, know the cost basis for your investments and understand basic capital gains tax terminology, the tax filing process will feel less daunting. But it won’t make the process less complicated for some taxpayers.
You will have to know your filing status, long-term capital gains tax and other details to file your taxes correctly. If it’s your first time filing for a capital gains tax or you feel you’re in a special situation, do your research on IRS.gov and contact a tax professional. Make sure your professional is credible. They should have extensive experience filing for investors, have reasonable rates and be willing to explain the process with confidence.
Need help filing your taxes? Check out Benzinga’s top picks for the best online tax software.
Frequently Asked Questions
What is the capital gains tax on $100,000?
The capital gains tax on $100,000 depends on your income and how long you held onto the assets. People with lower income who held onto their assets for at least a year tend to get lower capital gain tax rates.
At what age do you not pay capital gains tax?
Capital gains tax does not have an age limit. Retirees must still pay the capital gains tax, but a lower income tax bracket can help them pay less in taxes.
How can I avoid capital gains tax?
You can avoid capital gains tax by selling at a net loss, using retirement accounts like a Roth IRA or using Section 1031 if you recently sold real estate. Investors can use these strategies and others to avoid or minimize their capital gains tax payments. You should not participate in tax evasion as it is illegal and can get you into trouble.