You might’ve heard the myth that 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 it. But there’s good news: the portion of the tax code dedicated to capital gains tax is only 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?
- When Do I Have to File for a Capital Gain or Capital Loss?
- Steps to File Capital Gains Tax
- Step 1: Gather Relevant Forms
- Step 2: Define Adjusted Basis of Your Assets
- Step 3: Determine Holding Period
- Step 4: Figure Out the Proceeds from a Sale and Net Capital Gain or Loss
- Capital Gains Tax Rates
- Final Thoughts
What are Capital Gains and Capital Losses?
In its simplest form, a capital gain is any profit made from a sale of an asset. These 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. Why are these two related? Because of net capital gain or loss. More on that later.
When Do I Have to File for a Capital Gain or Capital Loss?
Taxable and nontaxable exchanges
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
But, there are some exceptions to the rule. Here are some common nontaxable exchanges.
- Like-kind exchanges or 1031 exchange: The exchange of two pieces of investment real estate that are of same value. Sometimes, the property from this must be held in order to be considered nontaxable.
- Exchange expenses: Any closing costs in real estate, brokerage commissions, attorney fees, and the like.
- Property plus cash: If you traded property and paid cash for the difference in price. For example, if you traded in your old car and paid the $12,000 difference for a new car.
You may want to consult a professional opinion 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 if you need to file for any certain activities
When do I file capital gains tax?
Generally speaking, you count capital gains in the year that the asset is sold. There are some exceptions, however. For example, if you bought your house in 2012 and sold it in 2016, you would file for the gain on you 2016 taxes.
Steps to File Capital Gains Tax
Ready to file? Follow these steps below.
Step 1: Gather Relevant Forms
Forms you’ll need to gather
Before you file, have relevant forms on hand. Most of these 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. It’ll show the exact you made for the year.
- 1099-DIV: If you made over ten dollars in dividends from an investment fund company, they’ll 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.
Forms you’ll use to file
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.
1099 forms should hold this information. Here’s an example. Let’s say you bought 50 shares of Google stock at $8 per share. Plus, you paid a broker fee of $50. The cost basis is $450. In some cases, the purchase price isn’t the cost basis.
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 side, if you held it for less than one year, 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. Short-term rates are 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 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’re short-term or long-term and gain. If you have a:
- Net capital gain or net long-term capital gain: If your long-term capital gains were more than your capital losses, you have a net capital gain. Lucky for you, net capital gains are taxed less than short-term gains.
- Net short-term capital gains: Short-term capital gains are taxed as regular income. You’ll pay taxes in graduated rates.
Once you have all of your paperwork and understand basic capital gains tax terminology, the tax filing process will feel much less daunting. But, it won’t make the process less complicated for some.
If it’s your first time filing for a capital gains tax or 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, has reasonable rates, and be willing to explain the process with confidence.
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