Capital Gains Tax Explained: A Clear Breakdown
Understand the tax implications of selling an asset. This guide clarifies the complete process, from calculating your final profit to proper reporting.
When you sell an asset for more than you originally paid, the resulting profit is a capital gain. The assets involved in these transactions are known as capital assets, which encompass nearly everything you own for personal use or investment. Common examples include stocks, bonds, jewelry, your personal residence, and household furnishings.
The Internal Revenue Service (IRS) defines capital assets broadly by what they are not. Items that are not considered capital assets include inventory for a business, depreciable property used in a business, and creative works like copyrights held by the creator. The profit you make from selling a capital asset is what triggers the capital gains tax.
Capital Gains Types and Tax Rates
The tax treatment of a capital gain depends on how long you owned the asset. This holding period separates gains into two categories: short-term and long-term, based on a holding period of one year.
A short-term capital gain is from selling an asset owned for one year or less. These gains are taxed at your ordinary income tax rates, which are the same progressive rates that apply to your wages and depend on your filing status.
A long-term capital gain results from selling an asset held for more than one year and is taxed at more favorable rates of 0%, 15%, or 20%. The specific rate you pay depends on your taxable income and filing status. For the 2025 tax year, the 0% rate applies to single filers with taxable income up to $49,230 and married couples filing jointly with income up to $98,450.
The 15% rate for long-term capital gains applies to single filers with income from $49,231 to $547,950, and for married couples filing jointly with income from $98,451 to $612,350. The 20% rate applies to taxpayers with income exceeding these upper thresholds. Certain assets have specific long-term rates, such as 28% for collectibles and 25% for a portion of gains from selling certain real property.
High-income earners may also be subject to the Net Investment Income Tax (NIIT). This is an additional 3.8% tax on investment income, including capital gains, for individuals with a modified adjusted gross income over $200,000 for single filers or $250,000 for married couples filing jointly.
Calculating Your Net Capital Gain or Loss
To determine your tax liability, you must calculate the gain or loss for each asset sale. The formula is the proceeds from the sale minus the asset’s adjusted basis. The proceeds are the total amount of money you received in the transaction, including any debts that were assumed by the buyer.
Your initial basis, often called the cost basis, is the original price you paid for the asset, including any commissions, fees, or other acquisition costs. This basis can be adjusted over time. For example, the basis of a rental property is increased by capital improvements but decreased by any depreciation deductions you claimed.
After calculating the gain or loss for each sale, you net these amounts. First, combine all short-term gains and losses to find a net short-term figure. Then, do the same for all long-term transactions to find a net long-term figure.
Finally, you combine these two net figures to find your overall net capital gain or loss. A net capital gain is the amount subject to tax. If you have a net capital loss, you can deduct up to $3,000 of it against other income in a single tax year, and any excess loss can be carried forward to future years.
Reporting Capital Gains on Your Tax Return
You must report your net capital gain or loss for the year to the IRS on your tax return. This process involves two primary forms: Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses.
On Form 8949, you list the details of each capital asset transaction. For every sale, you provide a description of the property, the date you acquired it, the date you sold it, the sale proceeds, and your cost basis. The form is structured to separate your short-term and long-term transactions.
The summary totals from Form 8949 are transferred to Schedule D, which is used to calculate your overall net capital gain or loss. The final figure from Schedule D is then carried over to your main tax return, Form 1040, where it is included in your total income.
Primary Home Sale Exclusion
Homeowners who sell their primary residence may qualify for the home sale exclusion. This provision allows single individuals to exclude up to $250,000 of the gain from their income. For married couples filing a joint return, the exclusion amount is $500,000.
To qualify, you must meet both an Ownership Test and a Use Test. The Ownership Test requires you to have owned the home for at least two of the five years before the sale. The Use Test requires you to have lived in the home as your primary residence for at least two of the five years before the sale, though these years need not be continuous.
You may qualify for a partial exclusion if you do not meet the two-year requirements but sold your home due to a change in employment, health reasons, or other unforeseen circumstances. In these cases, the exclusion amount is prorated based on the portion of the two-year period you met the requirements.